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2015 credit outlook: is the tide turning?

Andrew Palmer of Standard & Poor's outlines his outlook for 2015, including key regional risks and financing conditions.

How are credit conditions looking in Asia-Pacific as we enter 2015?
Credit conditions in the region appear to be slightly tighter, as some investors and lenders take a breath to re-evaluate their risk-return strategies against the backdrop of slower regional economic momentum. This may indicate an interim turn in the credit cycle, amide soft economic prospects, weak credit conditions, and a build-up of debt in the region,

What is S&P’s outlook for Asia-Pacific GDP growth, especially China?
Our outlook is slightly negative overall with Asia-Pacific economies losing momentum as they approach the finish line in 2014; the risks remain tilted toward the downside. We forecast real GDP growth for the region as a whole at 5.3% for both 2015 and 2016, in part reflecting somewhat slower growth for China. Our forecast for GDP growth for China is 7.1% and 6.7% for 2015 and 2016 respectively.

China's economy, which has been the stalwart of Asia-Pacific (and global) growth continues to slow, and trend growth is now below the authorities' target. The main drag on growth has been structural oversupply  in the property market owing to mispricing of credit combined with distortions caused by perceived government guarantees. To put it simply, too much credit has been financing too many developers. The correction is ongoing but, owing to data issues, the size of the required adjustment is unknown.

In other parts of the region we have seen Japan slip into recession (although we are encouraged by the subsequent policy response), India’s economy appears to be picking up steam, and external demand has yet to meaningfully improve across the region. 

What do you see as key regional risks in 2015?
We view a disorderly adjustment of China’s real property sector, if not managed by the Chinese government, as a risk that might adversely impact consumer and economic sentiment, growth and funding. This risk has already been longer and sharper than most had anticipated, and continues to be tilted to the downside.

The other major risk is an adverse market reaction to the Fed's process of monetary policy normalization. This will likely affect emerging markets more negatively than the US. itself. For now, Asia-Pacific is being spared from market turbulence. However, large unforeseen short-term fluctuations still hold the potential to expose various weaknesses. These could potentially introduce short-term funding stress due to capital outflows affecting those economies that have large external and fiscal deficits. Furthermore, possible asset-price corrections if global interest rates rise more rapidly than expected can mean difficulties in servicing debt. Economies that have increased leverage significantly over the past few years (Korea, Singapore, Malaysia, and Thailand) may be potential candidates.

Finally, a key global issue is geopolitical conflict leading to financial turmoil or economic shock.

What about financing conditions?
Regional bond markets continue to make inroads, although banks remain the predominant source of funding for corporate borrowers in the Asia-Pacific. While net interest margins are generally under pressure, the major banks in the Asia-Pacific have managed to keep their credit costs under control and have strengthened their capitalization. Consequently, banks in the region do have the capacity to cater for the credit growth momentum.

The likelihood of banks tightening loan supply is tied to the risks of GDP growth and property markets weakening beyond their expectations, resulting in sluggish economic environments which could see a sharp rise in credit costs and banks will not be able to absorb costs through their currently subdued interest margins. Currently, however, we think there is a low possibility of such scenarios unfolding.

On the matter of bonds issuance relative to GDP, we expect domestic private sector issuers in China to continue their upward momentum in 2015 while those in Australia to continue their slight downward momentum . For India, Indonesia, Japan and Korea, the domestic private sector bonds-to-GDP ratios are expected to be stable. (Insert chart 2).

From the investor perspective, while investment strategies vary across the region, we expect some large funds to continue to favor a carry-and-credit strategy while keeping durations low until market yields rise. Consequently, some funds will emphasize the intermediate part of the yield curve while remaining defensive in longer maturity bonds and buying selectively, in our view.

What is your ratings outlook for Asia-Pacific corporate sectors and financial institutions?
As we end 2014 and move into 2015 we have observed the net negative ratings bias for the Asia-Pacific issuers has eased to 11% at the end of November from 14% at the end of August, as worries about India recede.

In terms of corporate sectors, the automotive original equipment manufacturer (OEM) and supplier, project finance, and public finance sectors have shown an upward trend in terms of ratings bias. By contrast, the ratings bias trend for the real estate developer sector has been declining. Cyclical industries such as transportation, building materials, chemicals, real estate development, and capital goods also have above-average negative biases.

The outlook for Asia-Pacific's financial institutions remains negative. About 82% of the region's bank groups are on stable outlooks at Nov. 30, 2014, higher than 71% at the end of 2013. That's mainly because of the outlook revision on 11 Indian banks to stable from negative after a similar action on the sovereign.

Economic imbalances such as growing household debt and rising property prices in Australia, Malaysia, and New Zealand, as well as India's weak GDP growth and structural problems, are elevating risks.

Slower economic prospects across the region including China's, as well as high household and corporate debt in some countries, continue to weigh on banks' asset quality. We expect credit costs to rise, but at a gradual pace due to the region's relatively high GDP growth compared globally. That said, the banking sector's financial profiles remain sound overall, sustained by adequate capital and stable funding.

What about sovereign ratings?
The outlook on most Asia-Pacific sovereign ratings continues to be stable.

Over the next one-to-two years, we expect relatively steady global economic and financial conditions to prevail. The US. economy appears to continue to improve even if growth in household income continues to lag headline GDP growth. The gradual normalization of monetary policy in the country should continue as a result. Concerns over eurozone's economic performance have resurfaced in late 2014. Nevertheless, a sharp contraction of activities remains unlikely.

In China, as the authorities continue to guide the economy to reduce its reliance on investment demand, growth could sometimes fall more than policymakers expect. In such cases, we believe that modest policy changes will occur to reverse the slowdown. As such, we see economic performances supporting sovereign credit metrics near current levels in much of the region.

The author of this article, Andrew Palmer, is Asia-Pacific Regional Criteria Officer at Standard & Poor’s

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