Outlook 2018: is Asia's debt burden too heavy?

After 2017’s record issuance, issuers and investors wonder whether the market will be able to support even more borrowing in 2018 without spreads widening.

It has been a barnstorming year for Asian issuers across the credit spectrum. Throughout 2017, conditions have remained benign, facilitating record-breaking issuance particularly in high yield bonds.

No one expected 2017 to pan out that way. At the beginning of the year, all eyes were on rising US interest rates and geopolitical risks in the wake of Brexit and Donald Trump’s election as US president. 

Instead, European elections failed to create much drama and central banks held off raising interest rates, as inflation remained subdued. Money continued pouring into emerging market funds, enabling Asian borrowers to carry on raising cheap money, with spreads tightening to historically tight levels over US Treasuries.

As a result, G3 issuance from Asia ex-Japan has surpassed the $300 billion mark for the first time: standing at $312.4 billion as of mid-December according to data provider Dealogic. Chinese issuers represented more than 67% of the total volume.

In November ANZ forecast that G3 volume would hit $325 billion in 2018 in the region, driven by a mix of refinancing and a raft of maiden issuers.

“Ten-plus years ago the market saw $10 to $20 billion in issuance volumes during any given year – but now we’re sometimes seeing these levels during the span of a one or two weeks. The market has fundamentally changed,” Derek Armstrong, head of debt capital markets across Asia Pacific at Credit Suisse told FinanceAsia.

The National Development and Reform Commission (NDRC), China's top economic planner, has approved a list of 60 companies to issue bonds overseas since November, a remarkably short time frame, in an effort to relieve a liquidity crunch in the domestic market. These include some of the most acquisitive companies like Alibaba’s financial unit Ant Financial and Tencent, as well as a raft of property developers which are frequent issuers of high-yield bonds.

“We anticipate a strong start to the year, particularly given some issuers have approvals for offshore dollar bond issuance until March,” said Credit Suisse’s Armstrong.

However, this does not mean spreads will continue to tighten as well. Morgan Stanley, for one, is predicting an average 58bp widening for Asian credit during 2018 in its base case scenario.

Investors also face the challenge of how to diversify and reduce correlated risks. This is a big ask given the dominance of Chinese issuers and their vulnerability to changes in macroeconomic conditions and policy direction on the mainland.

For example, Morgan Stanley analysts argue that changes to financial conditions in China account for 25% of spread changes to Asian investment grade credit as a whole.

China is also hard to short.

“You’re essentially going against a government with $4 trillion of foreign exchange reserves at its disposal and a history of orchestrating bankruptcy proceedings,” said Gordon Ip, a fund manager at Value Partners, Hong Kong’s largest hedge fund.

Key will be how China’s regulators balance economic growth against advocating deleveraging to reduce high levels of corporate and local government debt.

A greater emphasis on growth, as appears likely, means investors should watch out for signs that debt in the world’s second-biggest economy will spin out of control.

 “The key concern is China’s increasing debt-to-GDP ratio,” said Joep Huntjens, head of Asian debt at NN Investment Partners. “However, we do expect it to be contained within a sustainable range.”

Between the 2008 global financial crisis and the end of 2016, total debt-to-GDP surged from 140% to 260%. In absolute terms, debt ballooned from $6 trillion to $28 trillion over the same period, according to official data.

This continuing debt buildup led both Moody’s and S&P to downgrade China’s sovereign credit rating to A1/A+ during 2017. As credit conditions get tighter, corporate borrowing costs have surged. In November, onshore sovereign and local government bond yields also climbed to their highest level in three years.

To be sure, banks have been lifting mortgage rates in an attempt to take some heat out of the property market without promting a crash.

“Offshore issuance by a municipal government such as Beijing or Shanghai might help to reduce leverage in the state-owned sector,” commented Ivan Chung, head of Greater China credit research and analysis at Moody’s.

“This would be a good step to rein in fiscal risks and bring down borrowing costs for some troubled companies,” he added.

A Goldilocks scenario?

One key issue facing Asian financial markets is how surging asset prices will cope if central banks accelerate their easing measures.

Yet while the US Federal Reserve has begun raising rates, it remains constrained by subdued inflation. Some believe this means a return to the Goldilocks scenario of stable growth and low inflation.

If it does,  bonds are likely to have another strong year.

“The biggest risk facing the Asian dollar bond market is economic conditions in the US, where wage inflation remains modest despite low unemployment rates,” Huntjens told FinanceAsia.

 “Forecasting inflation has become more uncertain and any sudden increase in inflation prints could trigger hawkish central bank behaviour.”

Bright spots

So where do investors think the best risk/reward ratio lies? In early December, FinanceAsia canvassed half a dozen international investors and the three most popular countries were Indonesia, India and Australia.

Indonesian credit has been on an upswing since S&P raised the sovereign rating in May, giving the country a full suite of investment grade ratings. India’s sovereign rating was also upgraded one notch by Moody’s in November.

Both countries have been credited for their efforts to boost fiscal revenues and institute sweeping reforms.

“Indonesia and India’s growth and structural reforms are encouraging and they also have better demographic outlooks,” said Huntjens.

As Asian debt markets enter 2018, investors are aware that bonds are priced to perfection. It will take just one geopolitical upset, a sudden jump in inflation, or a stock or property market correction to trigger a domino effect.

And yet, many said the same thing at the beginning of 2017, only for the benign conditions to continue.

Japan’s long deflationary cycle remains a warning to the bears. America’s long equity cycle remains a red flag to the bulls. Investors remain unsure whether to be cautious or optimistic. Perhaps the answer is to be a mixture of both.

This article has been updated

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