Asian bonds may still be a pupil in the broader Emerging Market (EM) asset class, but they are far from a monolithic entity. While some markets, such as China and Indonesia, are often referred to as EM, others like Korea, Hong Kong and Singapore are commonly considered Developed Markets (DM). As such, Asian fixed income possesses both EM and DM characteristics — but in many ways, it has already pulled ahead of many of its contemporaries and may soon graduate from the EM school.
In historical terms, 15 years is not an especially long time, but for the local currency (LC) bond markets, that is sufficient time for them to develop and mature into an asset class that is giving rise to new opportunities — and increasingly drawing attention from investors.
There are several aspects to this development, from specific bond market growth initiatives and an increase in issuance to deeper liquidity and growing foreign investor participation.
The 1998 Asian financial crisis sparked a massive devaluation of Asian currencies, with many plunging by 30–40%. This exposed the danger of taking on short-term foreign-currency debt while relying on long-term LC-generating assets for repayment — a currency and a maturity mismatch.
Although the 1998 crisis was the catalyst for the creation of active LC bond markets in the region, it was not until the 2008 global financial crisis (GFC) that the sector began its rapid growth. Cognisant of the danger of using excessive foreign-currency debt, Asian governments turned instead to LC bond markets to finance stimulus packages for combating the economic downturn; and as global liquidity began to run dry, local corporates also resorted to this market.
While the GFC caused temporary disruptions and capital outflows in LC bond markets, investor confidence swiftly returned, strengthened by enduring macro fundamentals amid a worldwide backdrop of fiscal stimulus and monetary easing.
This confidence was also aided by the variety of market-reform initiatives already undertaken by the region’s policymakers, including measures to strengthen financial stability via the LC bond markets, and pooling international reserves from regional central banks to invest in the US$-denominated sovereign and quasi-sovereign debt.
Reform initiatives continued even after the GFC had passed, with the establishment of the Asian Bond Market Forum (ABMF), the creation of the Credit Guarantee and Investment Facility (CGIF) and the implementation of the Asean+3 Multicurrency Bond Issuance Framework (AMBIF). All of these helped to standardise and harmonise market practices, bond issuances, investment processes and regulations, which have subsequently eased transactions.
Governments and their central banks also became more transparent in courting investors — for instance, announcing shifts in monetary policies proactively and timely. Central banks have been viewed as mostly independent, and the political climate has remained relatively stable when compared to their non-Asian EM counterparts.
This has helped the Asian LC bond space grow exponentially in the last 15 years, with assets growing eight-fold from approximately US$2 trillion at the end of 2005 to US$16 trillion ($22 trillion) in December 2019.
China has led this growth, rising from US$617 billion at the end of 2004 to over US$12 trillion by December 2019. During the same period, Hong Kong jumped from US$78 billion to US$291 billion, followed by Korea rising from US$657 billion to US$2.1 trillion, and Malaysia climbing from US$97 billion to US$363 billion — and so on.
Governments also began ramping up their issuance of longer-dated bonds to meet the rising need for longer duration investment assets. At the end of 2004, for example, government securities with maturities of over 10 years comprised 5.2% of all issuance in the Philippines; by end-2019 it stood at 36.0%. In Korea, such long-dated bonds increased from just 0.4% of all issuance to 33.9% as at September 2019.
From a liquidity perspective, there have been substantial improvements. Trading volumes have risen across the board. China saw activity surge from US$341 billion in 2004 to US$13.9 trillion for just the first three quarters of 2019. In Indonesia, it increased almost ten-fold from 2004 to 2019. And although the expansion in other economies was more modest, it was still apparent.
This was also reflected in the narrowing of bid-ask spreads. China’s spreads narrowed from 32.5 basis points (bps) in 2004 to 1.1 bps in 2019, Indonesia’s from 21.4 bps to 4.1 bps, and the Philippines’ from 25.0 bps to 2.8 bps. All these developments have led to an increase in foreign investors’ participation in the Asian LC bond space. Apart from China — which saw foreign ownership of LC government bonds more than double from 2.5% at end-2014 to 5.8% at end-2019 — other Asian countries saw exponential rises in external-ownership rates. In Indonesia, for instance, the percentage climbed from 2.7% at end-2004 to 38.6% at end 2019. Over the same period, Korea saw an increase from 0.4% to 12.3% and Thailand from 2.0% to 17.0%.
These new characteristics lay the foundations for the long-term growth of the Asian local currency bond market, despite concerns over Covid-19 and geopolitical tensions. In part, this will be driven by local governments continuing to tap the market for growth-related funding, but there are other reasons why the local currency issuances will only become more critical.
First, strong macro fundamentals and more dynamic economic growth in Asian economies will likely create significant financing needs for private-sector fixed investment. Second, the local currency bond market can help meet the rising demand for infrastructure investments. Third, rising incomes and wealth levels throughout the region will necessitate further investment opportunities, with local currency bonds serving as a potential investment avenue. Fourth, local currency bonds are significant vehicles for local institutional investors, such as pension funds. Finally, international corporations continue to establish offices and factories in Asia and will tap the market for their regional funding needs.
All these developments have laid a solid foundation for Asian LC bonds to become a strategic asset class, instead of just a tactical one.
Kheng Siang Ng is Asia Pacific head of fixed income at State Street Global Advisors.