Weaker growth rather than inflation is now clearly the main risk for emerging Asian economies, but while healthy fiscal positions allow room for stimulus packages, the global credit crisis means governments will have to look to local funding sources, according to the November issue of Asia Bond Monitor (ABM), released yesterday.
ôDomestic borrowing is likely to increase as funding becomes harder to access in the foreign market,ö says Jong-Wha Lee, head of ADBÆs Office of Regional Economic Integration. ôAlready we have seen the PeopleÆs Republic of China and the Republic of Korea unveil fiscal stimulus packages to boost their economies, a part of which may be financed through local debt issuance.ö
The report recommends that policymakers continue the reforms to deepen their local bond markets, pointing out that better transparency, stronger regulatory frameworks and tighter regional cooperation will improve liquidity and broaden the investor base.
Governments are already taking the domestic route and local markets have held up well compared to US dollar issuance. The ABM notes that despite the global turmoil, the regionÆs local currency bond markets û that is the 10 members of the Association of Southeast Asian Nations (Asean) plus China, Hong Kong and Korea û continued to expand in the first half of 2008, though at a slower pace. Between end June 2007 and end June 2008 the markets grew 8.1% to $3.7 trillion.
Aggregate local currency bonds outstanding rose in local currency terms in Vietnam (28%), Malaysia (13%), China (11%), Singapore (8%), Thailand (7%), Philippines (6%), and Korea (5%).
Government bond issuance dominates the domestic markets, driven by deficit financing and monetary sterilisation (normally to mop up excess local currency liquidity created by official foreign exchange intervention in support of local currencies). During the first six months of the year, the total size of government issuance increased 9.1% to $2.7 trillion.
Shifts in government bond yields have gone through three distinct phases so far this year. During the first six months, most yield curves moved up as many central banks raised interest rates to combat inflation that was partly caused by the spike in commodity prices û especially oil. Between July and September, yield curves shifted lower as investors lowered their inflation expectations and focused on the worsening credit crisis. Then, from September, ôglobal credit markets seized upö, sending investors on a flight to quality. This has driven government bond yields yet lower, helped by central banks throughout the region cutting short-term interest rates.
On the other hand, corporate bond issuance in the first six months of 2008 slowed as investors became more risk averse û the year-on-year growth rate fell to just 5.7% - forcing borrowing costs higher and resulting in some banks simply not lending at all. Also, in the past, Asian companies have preferred to raise debt capital from banks rather than bond markets as the latter have generally lacked a benchmark yield curve to price new issues. More government bond issuance in the future could rectify this shortcoming û a development which has long been desired by the ADB because it would lead to deeper, more sophisticated local capital markets, and take pressure off banksÆ balance sheets.
Crucially, the report notes that ôforeign holdings of local currency government bonds have risen as risk aversion has spikedö and suggests that this is a ôsign of growing confidence in emerging East AsiaÆs bond marketsö.
ôIt shows that if governments in the region can continue to develop their bond markets they will emerge as a prime source of capital to raise funds for the fiscal stimulus packages that will be needed to keep their economies moving,ö says Lee.
However, the ABM warns that tighter dollar liquidity, further de-leveraging by asset managers, and weakening regional currencies could dampen foreign investor interest.
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