Asian fixed income performance will remain flat in 2004, maintaining the narrow credit spreads that corporate and sovereign bonds achieved in 2003, says Andrew Freris, chief economist at BNP Paribas.
Freris predicts US interest rates will rise by May or June this year, with short-term interest rates up 150 basis points and long-term rates up by as much as 175 bps by year-end, but that Asia-specific factors will limit any widening of Asian spreads, despite the fact that most Asian corporate and sovereign credits are priced in US dollar terms.
"This is not to say that the US is unimportant for Asia, but that Asia is more important for Asia than the US is," says Freris.
Many Asian companies such as telcos, property concerns and banks are primarily dependent on domestic factors, not exports, for their sales and profits, he observes. Therefore the domestic economic environment is the key to determining the credit worthiness of these companies. Freris expects healthy Asian GDP growth this year, with economies growing at least as fast as 2003, if not faster.
Moreover, he expects most local Asian interest rates to remain low and unchanged. "Asian interest rates will not follow slavishly what happens in the US," says Freris. He notes that most Asian economies have flexible exchange-rate regimes and a growing degree of freedom in setting interest rates. With strong currencies relative to the US dollar and little fear of rising inflation or external imbalances, he sees no pressure for local economies to raise interest rates.
The exceptions are of course Hong Kong, China and Malaysia, which still maintain pegged exchange rates - but China and Malaysia maintain capital controls and the authorities need not adjust to US Federal Reserve monetary policy.
Hong Kong will not be able to resist following the Fed's lead, but Freris predicts an unusual delayed reaction. Hong Kong short-term interest rates are almost zero, well below the US interest rates of 1%-1.5%. Freris says that this negative differential is driven by expectations that the Hong Kong dollar will follow any revaluation of the renminbi. Once investors realize that the renminbi will not revalue in 2004 and US interest rates start to rise, Hong Kong's interest rates will have to adjust back in line with the US.
This will harry Hong Kong's domestic economy, leading Freris to predict that its property sector recovery will fail to reach its potential because of US interest rate hikes. This explains his negative credit outlook for Hongkong Land.
With elections in almost every Asian country this year, Freris caveats his analysis by emphasising that political uncertainty does get priced into corporate and sovereign credit spreads. He cites South Korea, Taiwan, the Philippines, Indonesia and India as particular areas of concern. "Political uncertainty always puts a question mark over interest rates and bond prices," says Ferris.
Freris' outlook for individual corporate and sovereign credits in the region have been put together in a "Compendium of Asia Pacific Credits", released yesterday by BNP Paribas. The report covers 109 Asian and Australian companies and sovereigns from nine different countries and nine industry sectors.
