Asian Bond Markets Improving But Still Need Catching Up.
4th March 2014
In recent times, Asian debt markets have seen sharp growth in bond issuance, but they still have a long way to go to reach the standards of markets in matured economies, writes Jagannadham Thunuguntla
An effectively functioning financial system linked to economic growth and well-functioning debt markets form an important part of any modern economy. Since the 1997-98 Asian financial crisis, all the Asian countries have been making continuous efforts to encourage financial cooperation with a focus on developing the region’s bond markets. Consequently, Asian bond markets have developed to become an increasingly high quality market. Recently, on the back of favorable global liquidity conditions and regional initiatives, bond issuance has grown many fold. Among all the Asian economies, the bond markets of Hong Kong, Singapore and Korea are comparatively advanced and have enough liquidity. However, markets in India, China, Indonesia and Thailand are still at an early stage of development.
No doubt, at present, Asia’s bond markets are better placed to face the volatility on the back of China’s slowdown and concerns about the (real) growth in the United States than they were in 1997-1998, but one cannot deny that tough times certainly lie ahead. Besides the corporate debt markets, Asia’s challenge also lies in rebalancing its economies away from excessive dependence on the United States (US) and European Union (EU) export markets towards more domestically and regionally driven growth. In order to win the race, Asian economies should develop proper local currency bond markets as it will make possible the mobilization of Asian savings for Asian investment, particularly in infrastructure, for which the deficits in many countries are big.
If we compare China with India, then we can summarize that in the last two decades, China’s bond market has grown from a virtually imaginary one into one of the world’s largest bond markets. However, although in absolute terms it has become one of the world’s largest bond markets, in reality there are quite a few bottlenecks that need to be removed if the Chinese want to get a larger share of the global market. For example, there should be liberalisation of policies in the bond market for increased foreign participation and a mechanism to create awareness about the various types of bonds available in the Chinese market as also about other concerns related to the Chinese bond market. The silver lining is that ever since the Chinese central bank started regulating the market, China has not defaulted in its publicly traded domestic debt markets.
China’s two bond markets – (a) the Inter-bank bond market (regulated by the People’s Bank of China), and (b) the Exchange bond market (regulated by the China Securities Regulatory Commission) – have several aspects to attract market participants. As the Inter bank bond market accounts for more than 95 percent of the total trading volume and of which 70 percent is dominated by Commercial banks; policy makers should now focus on improving the Exchange market. At present, however, China’s economic conditions are not as strong as it was in the recent past and market participants fear that the economy is slowing down. Moreover, there are also concerns regarding the opaque shadow banking industry.
If we talk about India, its bond market is still quite shallow. The presence of a corporate bond market in India is barely perceptible as compared to other economies. Despite several initiatives over the past one decade, market making has been difficult to put into practice. Actually, the Indian debt market is dominated by government securities. In 2013, however, Indian government bonds were badly hit due to high interest rates and also by the Fed’s announcement to taper its bond purchasing program. While untamed inflationary pressures have forced the Reserve Bank of India (RBI) to raise the interest rates, a decline in the economic growth has further hurt the sentiment for the Indian debt market.
The current year 2014 has, however, proved very lucky for the Indian debt market as foreign investors who had exited the country after the Fed hinted its tapering program in May 2013, have begun to come back. Asian bond markets, as a whole, are witnessing a resurgence as Asian borrowers are shifting away from short-term bank loans to long term debt financing.
Debt markets in Indonesia too have limited depth. In the last few months of 2013, political uncertainty and the Fed’s decision to taper its bond buying programe had badly hit both the Indonesian Rupiah as well as the country’s bond markets. However, the Indonesia Rupiah has gained 3.3 percent as against the dollar so far this year (2014). The recent gains in the Rupiah as also a spate of positive economic data have boosted bond prices. Just as it is for India, the lingering concern about Indonesia is its Current Account Deficit (CAD). It is expected that with improving debt management, a strengthening Rupiah and cautious economic policies will continue to attract foreign fund flow in the coming days.
Why Asian corporate bond markets have shot up?
Recently we have seen good participation by corporate borrowers in Asian corporate bond markets. Factors such as resilient fundamentals and improved (sovereign) credit worthiness, have worked as key “pull” factors. With developed economies keeping their interest rates low, investors flew towards Asia in order to get a good yield. Moreover, companies coming out with bond issues got a strong boost from regulatory and policy initiatives. At present regulators in Asia are taking initiatives aimed at deepening the bond markets and on improving infrastructure. As the Asian corporate bond market has improved in recent times, it has become a role model for other emerging economies who are trying to build resilience and reduce currency mismatches in the debt markets. The fast growth in the bond markets has facilitated well-organized financing for business needs, motivating investment and boosting economic growth.
The prevailing leading position of bank credit in corporate financing is increasingly being challenged in countries such as Indonesia, Malaysia, Thailand and India. In these countries, banks depend heavily on retail deposits, often more than 75 percent of their total funds. As the corporate sector, to a major extent, is dominated by family-controlled conglomerates, relationship-based lending continues to play a significant role. But in countries like China, corporate leverage and indebtedness have risen. More efforts are needed to build a framework that is both helpful to market innovation and enables companies to seek funding from a broader range of sources without increasing vulnerability to surprise. Policy makers and regulators are working hand in hand to encourage the issuance of local or unrated bonds to boost the use of bond markets for corporate funding. For example, Indonesia is now considering tax breaks for those who invest in the nation’s corporate bonds.
Conclusion
After the Asian crisis, bond markets have taken on a much more important role. However, despite the relatively rapid development, Asian bond markets are timid if compared with the standards of mature markets. Asian economies on the whole were very dependent on their banking systems for the provision of finance. If data points are to be believed, China stands out as having doubled the size of its corporate bond market as a share of GDP over the past four years (to reach 16.4% of GDP at the end of Q3 2013). At present, the efforts of governments in emerging Asia have boosted the developing capital markets and local bond markets. Some special attention has been given to remove policy bottlenecks; attractive market infrastructure has been created to support the implementation of corporate bond markets and developing government bond markets which can provide benchmarks for corporate bond markets. These efforts are essential because when a full-fledged corporate bond market is present in any economy, market forces have a much greater chance to emphasize themselves, thereby reducing systemic risk and the likelihood of a crisis. However, countries such as India and Indonesia have to get their act together quickly to build credible and reliable bond markets if they have to play an important role in the global financial architecture.