Asia's bond markets face rising risk of contagion

Emerging East Asia's local currency bond markets have weathered the recent market volatility well but risks to the markets are ticking up and countries need to be prepared, warned the Asian Development Bank's (ADB) latest Asia Bond Monitor.

"Good economic data so far this year, attractive yields and a recovery in some currencies mean Asia is still the best place to invest, but the threat of contagion is certainly higher than it was," said Head of ADB's Office of Regional Economic Integration, Iwan J. Azis.

To avoid being caught up in a general emerging market backlash from a crisis in one or two economies, Asia's governments should implement structural reforms to strengthen the resilience of their economies and promote productivity growth, the report said.

Contagion risk is highest for countries with large current account deficits and low foreign exchange reserves, while borrowers with high levels of foreign currency debt are most vulnerable if currencies depreciate.

Local currency bonds in emerging East Asia largely held steady in the fourth quarter of 2013 as turmoil dogged other emerging markets, although yields on most government bonds rose in January, most notably in Indonesia and the Philippines.

As the US reduces its purchases of US Treasury bonds in coming months, global market uncertainty is likely to continue.

That said, foreign bond holdings of the region's local currency government bonds held steady in the final three months of 2013 given the region's solid economic outlook and the attractive yield pickup versus other markets.

Indonesia had the highest foreign ownership at the end of 2013 with offshore investors holding 32.5% of outstanding government bonds, followed by Malaysia at 29.4%.

Emerging East Asia is defined as the People's Republic of China (PRC), Hong Kong - China, Indonesia, Republic of Korea, Malaysia, the Philippines, Singapore, Thailand and Vietnam.

The region's bond markets continued to expand in size. By the end of the year, the region had $7.4 trillion in outstanding bonds, 2.4% more than at the end of September 2013 and 11.7% more than at the end of 2012.

Vietnam's market expanded the fastest on a quarterly basis -- up 14.8% - while Indonesia posted the highest annual growth rate at 20.1%.

While governments have tended to issue local rather than foreign-currency bonds in recent years, many companies, such as real estate firms in the PRC, have been taking advantage of strong demand to issue US dollar-denominated bonds.

In 2013, the region sold a record $141.5 billion of bonds denominated in US dollars, yen, and euros, of which $128.4 billion were issued by the region's companies.

Depreciation in home currencies would mean higher debt servicing costs at a time when the domestic economy is also likely to be weaker. Gross local currency bond issuance by corporates last year was $765.6 billion.

Emerging East Asia's sales of sukuk, or Islamic bonds, remained strong at $91.7 billion last year, led by Malaysia and Indonesia. A special section in the monitor notes that sukuk have great potential as a source of financing for infrastructure projects but that governments need to put in place a suitable regulatory framework to encourage borrowers to use them more often.

Courtesy ADB