Debt is good

Could a developed domestic bond market prevent another currency-led Asian crisis? There is a case

Chua Soon Hock is in full agreement with the Financial Stability Forum's recommendations for a higher level of disclosure from hedge funds. The star investment strategist left Sanwa Bank last year to set up Asia Genesis Asset Management, a Singapore-based boutique fund manager that specializes in the Japanese bond market. The firm's aim is to "beat the global competition now dominated by the West".

Voted by Bridge News as the top trader in 1999, Chua agrees aggressive hedge funds can be a destabilizing force in smaller markets and should disclose more information.

Although his company is involved in hedge trading - "mainstream hedge trading", Chua stresses - he is philosophical about the danger of being exposed to predatory traders if one's trading positions are disclosed.

"It's a predatory world in hedge trading. Sometimes you are the hunter, sometimes you're the one being hunted."

That said, he suggests if Asian countries are to avoid further currency-led financial turmoil, the long-term solution is to set up their own bond markets, denominated in their own currencies.

Minimize risks

The theory is that bonds and equities are in-built stabilizers in the financial market. When in a boom, equity prices increase while bonds prices decrease. In times of economic woe, a well-developed domestic bond market can retain capital that otherwise would have rushed out of the country in a fit of panic.

Political factors aside, this theory rings true on two scores. In high savings and export-oriented countries, which all Asian tiger economies are, the high level of domestic savings can become an adverse factor when investors start a flight of capital to foreign currencies in times of economic troubles. Quality domestic bonds can minimize that outflow as equity markets wobble, thereby lessening the strain on that country's currency.

Second, as Chua points out, Latin America's nasty debt problems in the late 1980s did not bring the US economy to its knees despite its substantial interests in the region, let alone its own huge budget and trade deficits and low levels of savings. The country's government bond market was not only able to retain domestic capital, it actually drew in foreign investors, providing the much needed money to refuel its financial system.

Market equilibrium

Two caveats from Chua:áthe bond market should be of the same size as that of the economy or the equity market. Bond and equity markets generally grow in tandem. Their size equilibrium will ensure money fleeing the equity market can be adequately absorbed by domestic bonds. Also, in countries where the currency is regulated, the foreign exchange market must not be liberalized before the domestic bond and equity markets mature. That is because the risk of huge capital outflows will be high when the economy is in difficulties.

In the case of China, Chua's advice is to ignore the pressures from the WTO and the US to float the yuan, arguing its domestic bond market needs to command sufficient depth and liquidity before the yuan is floated.

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