The local currency bond markets in emerging East Asia have performed well so far in 2014, but face rising risks from earlier-than-expected interest rate hikes in the US, slowing property market in China and higher risk aversion and inflation due to rising oil prices fuelled by geopolitical tensions.

The latest quarterly of Asia Bond Monitor released on September 23 by the Asian Development Bank (ADB) showed that there were US$7.9 trillion in outstanding bonds in emerging East Asia as of end-June, up 2.5% from end-March and 9.3% from a year ago.

"Asia looks well-placed to face any volatility, but the risks are definitely rising," says Iwan Azis, head of the Office of Regional Economic Integration at ADB. "Higher US interest rates and a stronger dollar could also make it tougher for the rising number of US dollar borrowers to service their debt."

In China, a slowing property market is a concern because most collateralized borrowing is secured against property. A decline in property-related revenue could make it more difficult for local governments to service their bonds. Property companies have also become increasingly prevalent bond issuers themselves.

The report says emerging East Asia should prepare for possibly tighter liquidity as the US quantitative easing is expected to end in October. However, more expansionary monetary actions from the Eurozone and Japan could offset some of the impact on liquidity conditions caused by the end of the US quantitative easing.

Local currency bond issuance in the second quarter of 2014 amounted to US$1.1 trillion, up from US$852 million in the first quarter of the year. Meanwhile, sales of bonds denominated in US dollars, euros or yen in the first seven months of 2014 totaled US$121.4 billion, suggesting the region will set another record for annual issuance.

The emerging East Asia local currency bond markets continued to attract foreign interest, underpinned by improving investor sentiments as foreign bond inflows recovered strongly in Indonesia, Korea and Thailand in July.

Foreign investor holdings of local currency government bonds in emerging East Asia were generally stable. The only exceptions were in Indonesia where the share of foreign holdings rose to 35.7% at the end of June, and in Thailand, where they fell to 15.8% during the same period.

In terms of corporate bonds, the share of foreign investor holdings in local currency in Indonesia rose to 7.6% as at the end of June from 6.6% in March, while it remained steady from the previous quarter in Korea at 0.4% at end-March.

The maturity structures of emerging East Asia local currency government and corporate bond markets were mostly concentrated towards the shorter end of the yield curves - with tenors of more than one year to three years.

Meanwhile, the local currency government bond yields generally fell for most emerging East Asian markets between end-March and end-August, supported by ample global liquidity. The government bond yield curves shifted downward in Korea amid moderating growth, while Hong Kong, China interest rates fell, tracking the US interest rate movements.

In contrast, the Indonesian government bond yields rose during the period over concerns of a widening current account deficit.

The report notes an increase in sales of Chinese yuan-denominated bonds outside of China as the country has gradually liberalized the use of its currency for trade and investment. Since the first sale of the so-called dim sum bonds in 2007, the issuance volume expanded to 10 billion yuan (US$1.63 billion) in 2010 and 369 billion yuan in 2013.

To develop the market further, the report says greater participation from non-Chinese borrowers is needed. At the same time, there is a need for more higher-rated issuance not only to meet the investor demand but also to provide a pricing guide. Unrated issuance now accounts for the vast majority of the outstanding dim sum bonds.