Asia's Bonds Face Rising Risks from US Rates, Mid-East Tensions, PRC Property

Emerging East Asia's local currency bonds have performed well so far in 2014 but an earlier-than-anticipated US rate hike, a slowing property market in the People's Republic of China (PRC), and higher risk aversion and inflation due to Middle East tensions could undermine that, says a new report from the Asian Development Bank (ADB).

Asia looks well placed to face any volatility but the risks are definitely rising, said Iwan J. Azis, Head of ADB's Office of Regional Economic Integration. Higher US interest rates and a stronger dollar could also make it tougher for the rising number of US dollar borrowers to service their debt.

ADB's latest quarterly Asia Bond Monitor shows that as of the end of June, there were $7.9 trillion in outstanding bonds in emerging East Asia, 2.5% more than at the end of March and 9.3% more than at the end of June 2013.

Local currency bond issuance totaled $1.1 trillion in the second quarter, up from $852 billion in the first quarter. Meanwhile, sales of bonds denominated in US dollars, euros, or yen in January through July was $121.4 billion, suggesting the region will set another record for annual issuance.

Emerging East Asia comprises the PRC; Hong Kong, China; Indonesia; the Republic of Korea; Malaysia; Philippines; Singapore; Thailand; and Viet Nam.

Viet Nam was the fastest growing local currency bond market, both on a quarterly and an annual basis. However, the PRC remains the largest market in Asia after Japan, with $4.9 trillion in outstanding bonds. That marked a 3.4% on-quarter rise and a 10.8% annual rise, largely due to the increase in outstanding policy bank bonds and local corporate bonds.

In the PRC, a slowing of the property market is a concern because most collateralized borrowing is secured against property. A drop in property-related revenue could make it more difficult for local government to service their bonds. Property companies have also become increasingly prevalent bond issuers themselves.

In a special section, the report noted an increase in sales of Chinese yuan-denominated bonds outside of the PRC as the country has gradually liberalized use of its currency for trade and investment. Since the first sale of so-called dim sum bonds in 2007, issuance expanded to CNY10 billion in 2010 and CNY369 billion in 2013.

Although a greater variety of borrowers is tapping the dim sum bond market, PRC and Hong Kong, China borrowers still made up 73% of issuance last year. To develop the market further, greater participation from non-PRC borrowers is needed. Similarly, there is a greater need for higher-rated issuance not only to meet investor demand but also to provide a pricing guide, the report said. Unrated issuance now accounts for the vast majority of outstanding dim sum bonds.

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