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Emerging East Asia LCY bond markets face rising risks
The emerging East Asia local currency (LCY) bond markets are facing rising risks amid global concerns over the possibility of a Greek debt default and an interest rate hike in the US. As at the end of March 2015, the outstanding local currency bonds in the region stood at US$8.3 trillion as total issuances during the three-month period amounted to US$924 billion, down from US$1.032 trillion from the previous quarter.
Chito Santiago 23 Jun 2015

The emerging East Asia local currency (LCY) bond markets are facing rising risks amid global concerns over the possibility of a Greek debt default and an interest rate hike in the US. As at the end of March 2015, the outstanding local currency bonds in the region stood at US$8.3 trillion as total issuances during the three-month period amounted to US$924 billion, down from US$1.032 trillion from the previous quarter.

 
According to the latest issue of Asia Bond Monitor released by the Asian Development Bank (ADB) on June 23, the global interest rates, which had been falling up until April, have started picking up in early May due to a number of factors. These include the protracted negotiations over the Greek debt crisis, firmer oil prices, improving economic indicators in the US in April- May and faster GDP growth in the eurozone in the first quarter of 2015.
 
"Low liquidity in the region's bond markets could worsen the impact of an outlfow of funds leading to more volatilie price swings," says ADB chief economist Shang-Jin Wei. "Undertaking policies to improve efficiency and transparency of financial markets, coupled with some appropriate prudential regulation, can help countries strengthen resilience against external shocks."
 
The report warns that the risks to the region’s bond markets are rising, noting the expectations of higher US interest rates could result in greater volatility. While the US Federal Reserve is not expected to raise the rates until later in the year, recent upward movements in bond yields mean that markets may already be anticipating the rate hike.
 
“If bond yields gradually adjust, it will likely have minimal negative effects on the region’s bond markets,” the ADB says. “However, there is a risk that bond yields could rise sharply, as occurred during the “taper tantrum” of 2013, leading to sudden and disruptive sell-offs and capital outflows.”
 
Another indication that the risks are rising is that the lack of liquidity in the bond markets could magnify the volatility effect. It says a rise in the US interest rates could prompt a large outflow of funds from the region as the US assets will look more attractive. However, a large number of investors suddenly fleeing could be disruptive if there is not enough liquidity in the bond market.
 
At the same time, the increasing popularity of exchange-traded funds (ETFs) could also worsen volatility in the bond markets. While bond ETFs offer a liquid investment vehicle for investors, the underlying assets of a bond ETF are much less liquid than the ETF itself. If a large number of investors were to sell ETFs, there could be huge price swings in the underlying bonds.
 
The ADB also warns that a continued strengthening of the US dollar could hurt issuers of foreign currency-denominated bonds in the region. It says the higher interest rates could help push up the value of the US dollar. In 2014, foreign currency issuance in emerging East Asia totaled more than US$230 billion, with 82% of the amount comprising US dollar-denominated bonds.
 
While the pace of foreign currency issuance through the end of April 2015 was slightly lower than in the same period last year, the region has accumulated a large stock of outstanding foreign currency debts amounting to US$858 billion, of which the corporates accounted for US$712 billion.
 
“Companies that have issued US dollar debt will find their debt servicing costs increasing with the stronger dollar,” the ADB points out. “The impact will be stronger on companies that have not hedged or do not have foreign earnings that can offset some of the impact of the appreciating dollar. Refinancing debt may also become more difficult.”
 
Malaysia was the only local currency bond market in emerging East Asia that contracted in the first quarter of 2015, declining by 2.7% quarter-on-quarter to US$290 billion. The drop stemmed mainly from the decline in the stock of central bank bills, which slipped 46.8%. Maturing Bank Negara Malaysia bills were not rolled over as the central bank has not issued bills since December 2014.
 
Indonesia, on the other hand, reported the fastest quarter-on-quarter growth in the first three months of 2015, surging 6.5% to reach US$125 billion. Growth was largely driven by the government bond sector, particularly treasury bills and bonds.
 
China remained the largest local currency bond market in the region with outstanding bonds of US$5.28 trillion, or 63.8% of the total as at end-March 2015.
 
Meanwhile, foreign investor interest in local currency government bonds remained upbeat for select emerging East Asian markets despite the US dollar strengthening against most of the region’s local currencies. The share of foreign holdings in Indonesia and Malaysia continued to climb, with more than one-third of government bonds in both countries held by foreign investors at end-March.

 

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