One of the attractions of the Asian local currency debt market is that there is significant potential for performance from currency appreciation.
Most Asian currencies should continue to appreciate against developed markets over time. Asian currencies are supported by strong economic fundamentals, such as higher rates of growth and higher interest rate differentials versus the developed world. Equally, healthier public finances and less indebted consumers underline the region’s improving credit quality.
An outcome of the 1997 Asian financial crisis was the emergence of the local bond market as a viable alternative to US dollar-denominated bonds and the bank-centred financial system.
The local debt capital markets in the region sprang into action with a series of high profile issues, particularly from South Korea. It was the growing demand for a better diversified debt market, essentially to supplement a bank-led finance sector, which helped to accelerate volume growth between 1998 and 2003. Local issuers looked to the growing liquidity and competitive funding costs available, while bond investors warmed to the positive risk-return characteristics and currency exposure that the region’s debt markets offered.
There was a structural shift in asset allocation towards domestic debt markets in Asia which continues today. There was a 111 per cent climb in tradable Asian debt outstanding in that five-year period to 2003, from $783bn (£506.5bn) to $1.65trn, according to the Bank of International Settlements (BIS).
In 2003, the Asian Bond Market Initiative (ABMI) was set up by the Asean+3 Finance Ministers to create a more integrated regional market.
The ABMI is significant for a number of reasons. It was tasked with boosting local currency bond markets and channelling Asian savings into the region in the aftermath of the financial crisis in the early 2000s.
To facilitate this, the ABMI established a series of working groups concerned with the creation of standardised debt instruments, liaised with rating agencies, and provided technical assistance to market makers. Importantly the initiative has acted as a sounding board and point of reference for the different streams of issuers – whether Asian corporates, development banks or government debt agencies.
Issuance levels between 2003 and 2009 rocketed as a consequence. The level of tradable debt outstanding rose from $1.6trn to $5.03trn since ABMI’s launch – an increase of 204 per cent.
Today, the majority of emerging market debt is in Asia and Latin America, comprising 60 per cent and 25 per cent of the overall total, respectively. The rest originates from Emerging Europe and Africa and the Middle East (Source: Bank of International Settlements, BofA Merrill Lynch.
The Asian debt market includes bonds denominated in local Asian currencies and Asian external bonds, mostly denominated in US dollars. As of 2010, local Asian currency bonds represented 93 per cent of the outstanding total, according to the BIS.
China is the region’s bond powerhouse but accessing it remains a challenge for investors. Korea’s local currency-denominated bond market is the second-largest in Asia ex-Japan today, at just under $1trn, making it the single-largest bond market readily accessible to offshore investors India accounted for 13 per cent of local currency issuance in 2010 but, like China, is hindered by access issues, liquidity constraints within the government bond sector, and an over-reliance on the banks for capital.
In recent years, the Securities and Exchange Board of India (SEBI) launched initiatives to ensure more comprehensive reporting of the over-the-counter (OTC) bond market. However corporate bond issuance continues to lag nonetheless.
Domestic financial institutions such as banks, pension funds and insurance funds still dominate ownership of the local bond markets in the emerging markets. This is perceived as a positive, especially given local investors are typically more stable and long-term compared to external investors – sometimes called ‘hot money’.
Though China’s bond market, the largest in Asia ex-Japan, remains broadly inaccessible to most foreign investors, there have been a series of initiatives which suggest that investment restrictions will be lifted.
In August of 2010, The People’s Bank of China made the important decision to let overseas financial institutions invest yuan holdings in the interbank bond market, while keeping limits on the conversion of foreign currency for such investments. The programme started with foreign central banks and clearing banks for cross-border yuan settlement.
It is believed that China’s opening of its bond market to foreign banks holding yuan could boost global demand for the currency and enhance its potential as a foreign-exchange reserve asset. The Hong Kong offshore renminbi (RMB) market has proved hugely popular for issuers and investors. By the end of 2011, the volume of RMB-denominated bonds issued in Hong Kong is predicted to rise to 100bn yuan (£10.2bn), according to HSBC, and the aggregate RMB deposit there may hit 1trn yuan.
Other key developments in recent months have revolved around benchmarking the expanding offshore RMB market. In 2011, HSBC launched the CNH index, covering 29 outstanding bonds which account for 57 per cent of the entire RMB-denominated bonds auctioned, or 76 per cent for the bonds issued to institutional investors.
This followed last year’s decision from the Bank of China to issue the first offshore RMB bond index, which covers 28 offshore RMB bonds, valued at 54bn yuan that takes up 90 per cent of the overall offshore RMB bonds market.
The recent market developments further strengthen the case for diversification into emerging market fixed income, especially towards Asian debt and currencies. The strong public and private balance sheets in the region distinguish themselves from the sovereign debt problem and high unemployment in the US and Europe. Growth unavoidably will get dragged down by the global slowdown in the next few quarters, but Asia can definitely avoid a recession and will remain the fastest-growing region in the world.
Asian currencies are expected to appreciate modestly against the US dollar for the remaining of the year and after the sell off in global credits in the last few weeks some good investment opportunities started to emerge in the region, especially in the high grade spectrum.
