Emerging East Asia bonds can weather short-term risks

Short-term risks include general risk aversion toward emerging markets, faster-than-expected hikes in US interest rates, and escalating global trade tensions. Tightening liquidity conditions exacerbate the risk from the region’s rapid growth of private debt in recent years. Depreciation of regional currencies and capital outflows pose further risks to the region’s financial stability.

“Concerns about emerging markets are looming, but ultimately Asia’s strong fundamentals should attract investors back to the region’s local currency bond markets,” said ADB Chief Economist Mr. Yasuyuki Sawada. “That said, the region’s policymakers must closely monitor developments and keep up their guard against potential shocks.”

The report shows emerging East Asia’s bond market expanded 4.3% in the third quarter versus the second quarter to stand at USD12.8 trillion at the end of September. The growth rate was faster than the 3.2% pace seen in the second quarter. The third quarter growth came largely on the back of strong issuance of bonds in the People’s Republic of China (PRC), notably bonds issued by local governments for infrastructure projects. As of the end of September, the PRC had the largest bond market in emerging East Asia with USD9.2 trillion of bonds outstanding, 72% of the regional total, and 5.7% more than at the end of June.

Foreign holdings of local currency government bonds fell slightly across much of emerging East Asia in the third quarter of 2018, with the exception of the Philippines and the PRC. The share of foreign holdings in the PRC rose due to ongoing bond market liberalization.

The report also contains an annual bond market liquidity survey. This shows that liquidity conditions across the region are mixed with slightly lower liquidity in Indonesia, the Republic of Korea; Malaysia; and the Philippines. Higher liquidity was noted in the PRC; Hong Kong, China; Singapore; Thailand; and Viet Nam. Market participants continue to say that the absence of well-functioning bond hedging mechanisms and the lack of a diverse investor base are the biggest barriers to market development./.