Growth in emerging East Asia’s local currency (LCY) bond market slowed to 3.1% in the first three months of the year to US$23.5 trillion at the end of March, from 3.6% from the previous three months, amid weakened financial conditions and global economic headwinds.

According to the latest issue of Asia Bond Monitor published by the Asian Development Bank (ADB) on June 27, issuance in the first quarter of 2022 fell 6.5% from the previous quarter to US$2.2 trillion also on the back of heightened downside risks to economic outlook and on fiscal consolidation in some regional economies.

ADB notes that persistent inflationary pressure has led to the tightening of monetary stances in major advanced economies and several emerging East Asian economies. Financial conditions in emerging East Asia weakened between February 28 and June 9 amid ongoing monetary tightening and challenges facing the global and regional economies. These are being driven by continued inflation, rising commodity prices, a slowdown in China’s economic growth due to Covid-19 containment measures, supply chain disruptions and the Russian invasion of Ukraine.

“Monetary stances in emerging East Asia remain largely accommodative, but persistent inflationary pressure and accelerated monetary tightening by the US Federal Reserve could lead to further monetary tightening in the region,” says ADB chief economist Albert Park. “The region’s economies will continue to recover, but growth could moderate this year.”

Currency depreciations

Weakened financial conditions in emerging East Asia were manifested by currency depreciations, a retreat in equity markets, portfolio outflows and widened risk premium in most regional markets. During the review period, emerging East Asian currencies posted a simple average depreciation versus the US dollar of 3.2% and a GDP weighted average depreciation of 5.1%.

Aggregate portfolio outflows amounting to US$4.3 billion were recorded in regional equity markets from February 28 to June 9, mainly concentrated in South Korea, while portfolio outflows of US$21.9 billion were observed in regional bond markets from March to May.

Government bonds outstanding grew to US$14.7 trillion, or 62.6% of the total volume, in the first quarter of 2022. Issuance, though, contracted 2.2% to US$1.3 trillion from the previous quarter, as authorities tried to balance economic recovery efforts with fiscal sustainability. Issuance of corporate bonds declined by 12.1% to US$902.8 billion from previous quarter, bringing the outstanding volume to US$8.8 trillion.

Meanwhile, bond issuance in the Asean markets stood at US$393.5 billion in the first quarter of 2022, representing a decline of 6.7% from the fourth quarter of 2021 – and representing 17.8% of the total issuance in emerging East Asia. The sustainable bond market in Asean+3 (China, Japan and Korea) saw solid growth in the first quarter of 2022 to reach US$478.7 billion, with the private sector dominating the issuance activity.

Flight to safety

In terms of foreign holdings, overseas investors scaled down their stakes in government bonds in most emerging East Asian markets in the first quarter of 2022. Foreign investor sentiment towards the region was weighed down by the aggressive monetary policy normalization of the US Fed, the protracted status of the Russian invasion of Ukraine, soaring global commodity prices and the slowdown in China’s economy. “The combined effect of these adverse developments caused uncertainty and volatility in the market, leading to a flight to safety among foreign investors,” says ADB.

The China market experienced a slight decline in the foreign holdings’ share of government bonds to 10.8% at the end of March 2022 from 10.9% at the end of December 2021. In addition to concerns about economic uncertainty and slowdown in China due to Covid-19 mobility restrictions, the decline was also driven by the domestic bond market’s diminished yield advantage. While the US Fed began hiking benchmark interest rates, the People’s Bank of China did the opposite.

The foreign holdings of government bonds in Indonesia continued to decline in the first quarter of 2022 to 17.6% from 19% at the end of December last year. This can be largely attributed to the US Fed’s tightening policy and also to the government of Indonesia’s reduction in bond issuance to better manage its fiscal deficit.

The global risk-off sentiment also resulted in foreign investors reducing their exposure in the government bond markets of Malaysia and the Philippines, according to ADB. In Malaysia, the share of offshore holdings dropped to 25.6% at the end of March from 26% in December 2021, while in the Philippines, the decline was from 1.9% to 1.3% during the same period. Aside from the aggressive US Fed action, foreign investor sentiment soured towards the Philippine government bonds because of soaring domestic inflation, a large fiscal deficit and uncertainty stemming from the pending change in government administration, says ADB.