Asia's Bonds Pressured by Interest Rate, Currency Concerns - ADB Report

Emerging East Asia's bond markets came under pressure in the past quarter amidst concerns over softer growth, depreciating currencies, and US interest rates, the Asian Development Bank's (ADBs) latest Asia Bond Monitor said.

Asian bond markets were buffeted by strong headwinds, including anticipation of the US Federal Reserve rate hike, which has led to an outflows of funds in some countries, said ADB Chief Economist Shang-Jin Wei. The uncertainty in global bond markets points to the need for continued efforts to strengthen local currency bonds, which together with prudential regulations, can improve a country's resilience to foreign monetary and financial shocks.

The report notes that an improved US economic outlook could see the US Federal Reserve raise interest rates as early as September, although the monetary authority may take a more cautious approach given recent weakness in developing economies and declining oil prices. Meanwhile in Asia, currency depreciations pose threats to corporates with large amounts of foreign currency denominated debt, while further falls in commodity prices could hurt highly leveraged companies in the sector.

As a result, yieldswhich move inversely to pricesof local currency bonds spiked in a number of markets including Indonesia and Malaysia, which have a large number of foreign investors. At the same time, some markets, including the Peoples Republic of China (PRC), the Republic of Korea, and Thailand saw yields dip, as authorities took steps to soften monetary policy in the face of weak growth outlooks.

In the currency markets, adjustments by the People's Bank of China to the mechanism that sets the middle point for daily open exchange rates led to a 3.1% drop in the value of the renminbi against the US dollar between 1 June and 14 August, while the Malaysian ringgit fell 10.7%, the Republic of Korea won 6.3%, and the Thai baht 4.5%.

Despite some risk aversion by investors, East Asia's local currency bond market grew to $8.6 trillion at end-June, from around $8.3 trillion at end-March. As a share of gross domestic product (GDP), the size of emerging East Asia's local bond market reached 59.5% at end-June from 57.7% at end-March, lifted by an increase in the size of government bonds relative to GDP. Local currency bond issuance rose to over $1.4 trillion in the second quarter, from $958 billion in the first, led by increased issuance from the PRC; Hong Kong, China; and the Republic of Korea.

The report also contains a special chapter on Emerging East Asia's Sukuk (Islamic bonds) market, noting that it remained broadly firm in the 6 months to June despite pressures from developments in the global economy. The market posted modest growth in the first half of 2015, driven by rising acceptance of Islamic debt instruments as an important source of financing for infrastructure. Outstanding sukuk debt in East Asia totaled $186.3 billion at end-June, up 6% from the end-December 2014 level, while since end-2008 the market has posted a compound annual growth rate of over 19%.

The chapter noted that while the amount of outstanding Sukuk is up overall, the volume of new issuance in 2014 at $78.5 billion was below the 2012 high of $89.7 billion, reflecting broader investor caution towards emerging markets debt in the wake of the US Federal Reserve's announcement that it was winding down its quantitative easing activities.

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