Emerging East Asia LCY bonds up as potential risks loom

Escalating global trade tensions, rising debt levels pose threats to Asia's local bond markets

The total size of the local currency (LCY) bond markets in emerging East Asia continued to increase in the second quarter of 2018 to US$12.8 trillion at the end of June, up 3.2% from the previous quarter. However, they face a number of potential risks, including the escalating global trade tensions, rising private debt level in some economies and volatile global oil prices.

According to the latest issue of Asia Bond Monitor published by the Asian Development Bank (ADB) on September 21, the ongoing trade tensions between the US and China may adversely affect business and consumer confidence as most countries in the region have very close economic ties with the world’s two largest economies.

The private debt level in the region, which has grown rapidly since the global financial crisis, also poses additional downside risk as it may become a source of instability especially since the global financial conditions are now tightening.

Another risk comes from the global oil prices volatility due to geopolitical developments such as the imposition of economic sanctions against Iran and the domestic political problems in Venezuela. Yet another potential risk to financial stability is the new financial technology underlying bitcoin and other cryptocurrencies.

“To sum up, the downside risks to emerging East Asia’s financial stability currently outweighs the upside risks,” the ADB says.

These potential risks loom as bond yields in emerging East Asian markets diverged between June 1 and August 15, with yields rising in economies that took steps to support local currencies or tackle rising inflation, such as Indonesia, the Philippines, Thailand and Vietnam.

On the other hand, yields are sliding in countries such as Korea, Malaysia and China, with the latter lowering the reserve requirement ratios for some banks.

The trend occurred amid the global uncertainty as the US continued to raise interest rates and the Eurozone is expected to commence monetary tightening, which have contributed to the depreciation of most currencies in emerging East Asia.

“The difference in bond yields reflects disparate monetary policy stances across emerging East Asia in the wake of the global economic uncertainty,” notes ADB chief economist Yasuyuki Sawada. “But emerging East Asia still has strong fundamentals, and the current risks posed by financial turbulence in emerging markets such as Argentina and Turkey seem limited for the region.”

In terms of countries, China remains the largest bond market in the region, accounting for 72%, or US$9 trillion, of the total bonds outstanding in the second quarter of 2018, up 3.8% from the first quarter. The expansion was mainly driven by the surge in the issuance of local government bonds as the local governments rushed to meet the August deadline of the debt-for-bond swap programme.

Vietnam is the only country in emerging East Asia that exhibited a contraction in the local currency bond market in the second quarter of 2018, falling 1.4% quarter-on-quarter to US$51 billion following a 10.8% increase in the previous quarter. This was driven by the downtrend in outstanding government bonds, which fell 2.1% quarter-on-quarter during April-June 2018.

Meanwhile, Vietnam’s corporate bond market remained underdeveloped, but continued to expand, posting a robust growth of 10.6% in the second quarter of 2018.

Net foreign fund flows in the local currency bond markets in the region were mixed. For instance, foreign bond investment in Indonesia declined from 39.3% at the end of March to 37.8% at the end of June as investors were cautious over the continued depreciation of the rupiah and the deterioration of the current account.

In Malaysia, the uncertainty over the new government’s policies kept foreign investors at bay, ADB says, with the foreign holdings dropping from 28.9% at the end of March to 24.8% at the end of June. In addition, investors were concerned about the fiscal implication of the revelation that the government debt may be higher due to debt obligations related to 1MDB that were previously unreported.

On the other hand, Korea and Thailand continued to attract foreign investors with slightly higher market shares due to their solid economic fundamentals. In Thailand, the foreign investors’ share of government bonds increased slightly from 15.2% to 15.7%, while that in Korea rose from 11.2% to 11.6% during the same period. 

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