HSBC's house view on the sovereign debt crisis

FinanceAsia spoke with HSBC's Dilip Shahani and Sean Henderson about Europe's credit crisis and its implications for Asia.

As Europe continues to deliver a series of band aid solutions to an ever deepening sovereign debt crisis, Asian credit markets are seeing spreads widen in sympathy with the worsening credit markets in Europe and the US.

After the €110 billion ($145 billion) bailout package was issued to Greece on May 2, the market had thought the debt problems were on the road to repair. However with last week's relapse, coupled by escalating political tension in Greece, it was very clear that the band aid had come off.

In response, the European Central Bank on Monday announced a €750 billion ($962 billion) package to prop up the struggling sovereigns across Europe. Initially this seemed to settle the markets, but in the past couple of days it has become clear that the markets remain fragile and it may only be a matter of time before there is another negative reaction.

Realistically, plugging a debt hole with debt does not seem like the long-term solution needed to get the region and the globe out of its rut. But the latest move has bought more time for the EU governments to hopefully identify a clear exit out of the crisis.

FinanceAsia sat down and spoke with HSBC's Dilip Shahani, head of global research for Asia-Pacific, and Sean Henderson, head of debt syndicate for Asia-Pacific, to get their perspective on what is happening in Europe and to hear what the implications are for Asia's debt capital markets.


What is your take on recent events in Europe?
Shahani: We've been writing since December that the Asian credit markets would face a correction triggered by external events and those specific to the region. We had minor wobble in late January that was believed to the necessary cleansing of weak position but we are in process of an even deeper correction as a confluence of events diminishes risk appetite for the moment.

It seems that the measures taken are not addressing the root problem of too much debt in Europe. What is your take on the current proposal?
Shahani: From our perspective, European officials have addressed investors concerns about the near-term liquidity of weaker group members. However, market participants are also worried about the significant fiscal tightening required by these weaker European sovereigns against the backdrop of slowing economic activity and the rising number of unemployed.

Besides the market concerns about European public sector finances, we also believe the Chinese authorities desire to the cooling speculative residential property activities and the uncertainty around the regulatory measures to make large global financial institutions safer are some of the other unresolved issues weighing on investor confidence at the moment.

With band aid solutions being applied, is there a risk that a relapse will occur three months down the track?
Shahani: We believe the European authorities have shown commitment and hence will adopt a 'whatever it takes approach'. This strategy has resulted in a strong initial rebound of financial markets inclusive of credit from very oversold positions. Naturally, there will be relapse as market participants question weaker European sovereigns willingness to adhere to fiscal consolidation over a short timeframe.

In addition, market participants in Asia will be watching closely for any further action the Chinese authorities might take to dampening the speculative elements in the China property sector.

Having said this, we believe this is nothing for than a much need corrective phase for the Asian credit markets that was getting slightly ahead of fundamentals. There is excess spread in the Asian high-grade space versus comparables in the European and US markets for the same rating.

Henderson: I think that the Asian credit markets are certainly still sensitive to global sentiment however as we've seen in recent new issues, deals have managed to execute despite the volatility. In essence, the fundamentals of the best Asian credits remain strong and so interest from investors continues to persist despite global headlines. In fact often the spread widening has been offset to a large degree of even more by the falls in underlying treasuries.

In addition, there remains a relative undersupply of the best quality names from Asia and so investors are prepared to run through near term volatility in order to gain a long term position in these names. In the Asian high yield sector however things are a little different.

There is much more diversity in the quality of issuers and the big blue-chips have a huge following while the rest of the sector is incredibly name specific and has to target more niche investor audiences. Sentiment towards the sector as a whole is also relatively more affected by high volume issuers such as Chinese property, but overall stronger names still offer good opportunities from a relative value perspective.

Are you saying the system does not support growth?
Shahani: Yes there can be global growth but it cannot be at too fast a pace because of the huge public sector debt loads in the industrialised world economies. Faster growth requires investors to demand higher yields which the weaker industrialised sovereigns cannot pay right now. On the flip side, the developing world faces asset and general price inflation as these countries attempting to shadow monetary policies to limit currency appreciation as they still fear losing export competitiveness.

In short, a muddle global growth scenario works better for Asia's credit markets as it diminishes upward pressure on industrialised worlds policy rates and potential asset/general inflation in the Asia-Pacific region.

Would you say then that this is a bear market?
Shahani: No, it is a corrective phase for the Asian credit market after a very strong performance since March 2009. Asia's underlying economic fundamentals are solid and technical factors of the credit markets such as excess spread and limited high grade supply are very supportive for the medium-term.

Are the Asian markets proving to be as resilient as we had thought they might be when Greece was first bailed out in April?
Shahani: There is no simple answer. The fundamentals in Asia are more constructive than Europe and the US, but they are not completely decoupled in the near term since all investors are affected by sentiment.

Henderson: I'd agree, while market sentiment will inevitably impact spreads globally and Asia cannot escape this, on the other hand it's also clear that relatively speaking Asia has outperformed. I expect this to continue over the medium term as we continue to see more and more interest from the larger global funds in terms of how much of their portfolios are allocated to Asia.

This isn't something that reverses in a hurry. My view is decoupling is happening but it isn't a binary event but something that plays out over time. Some may argue things haven't decoupled at all since spreads have all moved out, but correlation in market weakness is inevitable and the decoupling will take time to play out, likely starting with the region bouncing back faster and further every time these bouts of volatility arise.

With so much volatility in the West, Asia is often described as a safe haven credit market. Is this a title we will be able to maintain once Europe and the US regain some stability?
Henderson: To some extent the market has been a relative safe haven, however it's tough to say it's a large enough a part of the global investor communities investment strategy to really play that role effectively. There are a number of reasons why including how long it takes investors to put resources on the ground to diversify into the region, how fast they can get up to speed with the various credits, the relatively limited number of big corporate benchmarks to achieve the diversity they want, and so on.

On the other hand, many of the biggest funds are seriously thinking about how long they can continue to view Asia as a spread pick-up play or simply an emerging market strategy going forward. There comes a point at which Asia should arguably make up a much more meaningful part of their overall asset allocation strategy if only because of the relative value and strong fundamentals, or as mentioned before, the relatively lower volatility recently.

In terms of value, there are clearly also still opportunities relative to Europe or US. For example a lot of single A rated corporate bonds in Europe trade in the 50bp to 100bp range over LIBOR, whereas Asian corporates can still be found in the 100bp to 150bp range. That spread differential is arguably not justified in many cases.

So, Asian corporates will come out on top through this crisis?
Shahani: There's more interest in the region but you've got to be careful with what you pick. For example, China property is a sector where there are a lot of challenges. Asia is not a homogenous market.

Henderson: The blue-chip corporates that have critical mass, diverse business profiles and operate in more interesting markets or economies - these will still remain very attractive to investors in my opinion. I expect these names to outperform many European and US counterparts over the next few years. Strong high yield names will also continue to see strong demand but we may also see some casualties. I expect however these will mostly be among the weaker and second tier corporates, where market access will continue to come and go with the volatility.

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