What are your views on the outlook for growth in the region in 2011?
We expect the Asia locomotive to remain on track, albeit slowing somewhat next year. Our forecast is for GDP growth in emerging market Asia to moderate to 7.6% in 2011 from 9.1% this year, before reaccelerating to 7.8% in 2012 – with growth continuing to be driven largely by China and India. We see this as a mid-cycle slowdown, reflecting capacity constraints, lower external demand and a gradual withdrawal of fiscal policy support. Countering these factors, drivers of business investment remain robust, as do the drivers of consumption expenditure, enabling Asian growth to remain well above levels seen in other regions.
So drilling that down, what's your forecast for Asian fixed-income markets specifically?
With central banks in the US and Europe keeping monetary policy very loose, we expect the focus on emerging fixed-income markets, including Asia, to accelerate further in 2011. While 2010 was about the global hunt for yield – with fixed-income markets across the board turning in a stellar performance – next year we expect to see a much greater differentiation in performance. In a number of markets, current valuations leave little room for error, making return generation more challenging and giving rise to an environment that will require a greater focus on fundamental and technical analysis to outperform.
What dynamics do you see driving the US dollar-denominated bond markets in the region?
In 2010, we have seen a broadening of the US dollar credit market, with a number of first-time issuers helping to push issuance to record levels. Looking ahead, on the sovereign side, we are now seeing regular borrowers, such as Indonesia and the Philippines, adjust their financing mix and moving away from foreign currency bonds. The corporate sector looks set to remain active with regard to US dollar bond issuance, since the necessary tenors and sizes cannot be achieved in the onshore markets. The surge in emerging market corporate bond funds and mandates linked to emerging market corporate benchmarks makes for a healthy backdrop in terms of international demand for Asian products. At the same time, we are seeing increased demand within the region – across the investor spectrum, from private banks to money managers.
What dynamics do you see driving local currency bond markets in the region?
Inflows into emerging market local currency bond funds stand at more than $16 billion year-to-date, and there are no indications of the momentum slowing. With the global growth backdrop remaining uncertain and contributing to strong inflows into emerging markets, central banks in the region will continue to have their work cut out in balancing currency appreciation against inflation pressures – a dynamic that could lead to increased volatility, particularly in the short end. We also expect increased investor interest in corporate bonds that are denominated in local currencies, but settled in US dollars.
What is your outlook for sovereign fundamentals in 2011?
We see a stable to improving backdrop for emerging market Asia sovereigns. While events in Europe have led to a renewed focus on sovereign debt and deficit levels, they have served to highlight the marked contrast with Asia. Most Asian sovereigns are comfortably placed in their credit ratings and, indeed, have improving metrics. Specifically, we believe Indonesia will merit an upgrade from two of the international rating agencies in late 2011. We also see potential for an upgrade in the rating outlooks for Sri Lanka and the Philippines.
And for corporations?
So far, companies in the region have been fairly conservative in managing their balance sheets. Given the increasing differential between the cost of debt and the cost of equity, we do expect to see some pick-up in M&A activity and shareholder-friendly activities (capital returns, dividend payouts) – but not to an extent that threatens our broadly sanguine outlook for corporate credit fundamentals. Opportunistic debt issuance is also likely. For such sectors as Chinese real estate, regulatory risk will remain the overarching driver, with liquidity remaining adequate for most companies in our coverage universe.
What does Basel III mean for Asian banks?
The impact on Asia-Pacific banks from the new guidelines under the Basel III framework will be less pronounced than in Europe and the US. This reflects the relatively prudent balance sheets and the limited amount of government intervention in recent years. But banks in the region have still been looking to boost capital and liquidity in response to global trends, and we expect the adoption of these new guidelines (albeit with a number of local regulatory interpretations) to have an incrementally positive impact on bank fundamentals.