Volatility on the Rise, Risks Loom in Asian Bond Markets, Says ADB Report | Asian Development Bank

Volatility on the Rise, Risks Loom in Asian Bond Markets, Says ADB Report

News Release | 23 April 2008

MUMBAI, INDIA - The most immediate and visible fallout from the global credit market turmoil has been an increase in volatility in emerging East Asian bond markets, says a new report issued by the Asian Development Bank (ADB).

Credit tightening in emerging East Asian economies has not been severe in the wake of the U.S. subprime mortgage turmoil, the April issue of Asia Bond Monitor (ABM) says. But corporate bond yields have edged up as investors seek risk premiums, while some borrowers have delayed bond issues, relying on short-term bank finance rather than longer-term debt issuance.

At the initial stages of the recent credit tightening, emerging East Asian local currency bond markets benefited as investors chased attractive returns outside U.S. markets. But as risk aversion in global markets spiked, foreign investors began retreating from Asian markets causing a rise in volatility in domestic capital markets.

The pace of government and corporate issuance has slowed but not to the same extent as a decline in global bond issuance. The region's offshore bond issuance market has slowed markedly and securitization markets have largely dried up.

ABM says the outlook for emerging East Asian bond markets is of continued growth, but at a slower pace. It highlights that domestic credit, supported by ample local savings, continues to provide resources for investment even as portfolio equity and bond flows taper off.

"Governments in the region carried out key reforms in the secondary market in 2007. They need to continue to improve bond market liquidity and strengthen risk management," says Jong-Wha Lee, Head of ADB's Office of Regional Economic Integration (OREI).

ABM includes a survey to identify key determinants of bond market liquidity. The survey finds that amid growing risk aversion, illiquidity of the region's local currency bond markets is a limiting factor in their development.

Increasing investor diversity, availability of hedging tools, consistent secondary market pricing and a more investor-friendly tax structure in corporate bond markets are measures that can help promote more liquid regional bond markets.

ABM says emerging East Asia's local currency bonds outstanding expanded at an annual rate of 21% in the second half of 2007 from 10% in the first half of last year. Government bond markets grew 21%, largely driven by central bank sterilization and fiscal stimulus. Corporate bond markets grew by 20%.

Heightened inflation risks, the slowdown in global growth and fears of external shocks led to increased volatility in local currency yield curves in 2007. Despite the global market turbulence, the ABF Pan Asian Index gained 8% in 2007 in US dollar terms, partly lifted by stronger regional currencies. The index gained 13.6% in 2006.

ABM cites three main risks to regional bond market outlook: (i) a deep or protracted U.S. economic contraction, (ii) continued global capital market volatility placing pressure on investors to cover rapidly shifting positions, and (iii) rising inflation in the region constraining policy options as growth slows.

It urges policymakers to focus on five key challenges to make local currency markets more vibrant. These are (i) boosting investor confidence by strengthening legal protection and corporate governance, (ii) reduce barriers to market entry and encourage investor diversity, (iii) development of derivative markets and increase liquidity, (iv) better data compilation, and (v) tighten regulatory oversight.

The April edition of ABM has a theme chapter on bond market developments and challenges in India. It says India's government bond market has grown steadily in size, largely due to the need to finance its fiscal deficit and is comparable to many government bond markets in emerging East Asia. But domestic corporate bond market remains less developed, with private placements dominating.

Like many emerging economies, the investor base in India remains narrow in both government and corporate bond markets, with limited foreign participation. ABM urges regulatory supervision in local bond markets to be streamlined to create a more level playing field for investors.

ABM examines local currency bond developments in emerging East Asia defined as the Association of Southeast Asian Nations member countries, plus the People's Republic of China, Hong Kong, China and the Republic of Korea.