S&P sees risks rising in Asia Pacific

Global ratings agency Standard & Poor's (S&P) on Tuesday said the risks for debt and equity investors in the Asia-Pacific region, including India, will grow in 2007.

It said the Asia-Pacific financial markets will remain generally strong in 2007, but higher financing costs, increased corporate borrowing and a frenzy of mergers and acquisitions (M&As) will fuel market volatility and add to the risks faced by investors. S&P said these are the findings of its Asia-Pacific Markets Outlook 2007.

The outlook combines S&P's expectations for equity markets, credit quality and economic performance across the region.

According to the report, the positive economic and market conditions that underpinned the Asia-Pacific markets in 2006 will persist in 2007, despite the US economic slowdown, and this will encourage greater corporate leverage, deepen the high-yield market and fuel an already overheated M&A market.

As a result, a slight rise in corporate defaults and more "fallen angels" (issuers moving from an investment-grade credit rating to high-yield grade) are likely next year, S&P said.

At the same time, a continued boom in M&As in the region will increase share price volatility and the credit profile of potential acquirers and target companies, raising new uncertainties for debt and equity investors.

In 2007, the rise of leveraged buyouts and private equity investment in the region will exacerbate the risks, especially for bondholders, it added.

"The wheels are still firmly on the Asia-Pacific market juggernaut, but they will not be spinning quite so dizzily in 2007. Although the trend is still broadly positive for the year ahead, there will be some negative credit stories too," said Ian Thompson, chief criteria officer for S&P ratings services in Asia-Pacific.

Lorraine Tan, vice-president at Standard & Poor's Equity Research in Asia-Pacific, noted, "After such a spectacular performance in the second half of 2006, there is less upside potential for the Asian markets in 2007.

Corporate earnings should be supported by strong domestic consumption, but tighter liquidity will have a dampening effect on regional stock markets." S&P's equity research is recommending over-weighting South Korea, Taiwan and China (H-shares) in 2007 and under-weighting Indian and Japanese equities.

S&P expects economic growth in Asia-Pacific to again exceed most other regions in 2007. This will be underpinned by a growth recovery in Japan, continuing momentum in China and India and growing intra-regional trade, which will offset the impact of a slowdown in the US. The potential for a housing "bubble" burst remains, but property prices should continue to be supported by pent-up demand and rising middle class incomes.

However, corporate earnings growth is coming under renewed pressure. "We believe earnings growth in 2007 and beyond will feel the pinch from rising input costs, wage growth, a heavier debt burden and higher interest rates," noted Thompson.

Labour constraints, in particular, loom as a threat. Wage pressures are expected to build in Asia because of higher living costs, increased pension and healthcare costs, skills shortage, rising employment levels and slower growth in the labour pool.

Standard & Poor's expects the region's financial markets to continue to broaden and deepen in the year ahead.

Rapid development of both the commercial and residential property markets will lead to greater issuance of REITs and mortgage-backed securities, while growth in infrastructure investment will rely increasingly on financing in the capital markets.

At the same time, the trend towards Asia-Pacific corporate champions acquiring in overseas markets, including Europe and the US, will accelerate, stimulating both debt and equity issuance in international capital markets.

"We are encouraged by regulatory developments that are improving transparency, strengthening the local financial sector and spurring foreign investment throughout the region," commented Tom Schiller, executive managing director and head of S&P Asia-Pacific.

"We would like to see governments continuing to support the integration of local markets into the international capital markets. This process is bringing real and lasting benefits to local economies and to international investors."