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Bonds

Analysts upbeat over short-term future

PUBLISHED : Sunday, 02 December, 2007, 12:00am
UPDATED : Sunday, 02 December, 2007, 12:00am

Although there has been fresh news about further credit turmoil emanating from the subprime market crisis in the United States, analysts believe that the Asian business cycle will remain unscathed even if the US economy is heading towards recession.

Interest rates were trimmed by 25 basis points to 4.5 per cent in late October in an effort to revitalise the US economy which has been hit by a crisis in the housing market. Analysts at HSBC believe the US's easy monetary policy coupled with local rates is fuelling asset inflation across Asia.

'To counter the rising inflation threat, countries like China, India, Indonesia and Vietnam have been primarily raising banks' reserve ratio requirements to drain excess liquidity and cap prices of selective items,' they wrote in a research report.

'Unfortunately, this gradualist monetary approach is only likely to encourage investors to chase Asian assets even harder in the belief that the current above-trend Asian economic growth is sustainable.'

The issuance of sovereign bonds in Asia this year has increased. The value of local currency bonds was US$3trillion, 9.9 per cent above the US$2.7trillion outstanding at the end of 2006 and 17.2 per cent up from June 2006, according to a report published by the Asian Development Bank on November22.

Vietnam's bond market grew the fastest in the first half of the year at a rate of 44 per cent. The second fastest was the mainland with 13 per cent growth.

The size of the Malaysia bonds market has increased by 12 per cent, Indonesia by 10 per cent, Thailand by 9 per cent, Singapore and South Korea by 7 per cent, Hong Kong by 4per cent, and the Philippines by 4per cent.

'Most Asian governments are in good shape financially,' said Kenneth Lee, head of syndicate for Asia Pacific at Barclays Capital. 'With a weakening US dollar and a widening of interest rate differentials in some Asian countries against those in the US, I expect the Asian local currency bond markets to grow next year.'

HSBC's report also shows that the Asian Dollar Bond Index (ADBI) posted gains of 1.53 per cent in October with average spread one basis point firmer.

The Asian high-yield Bond Index (AHBI) has benefited from its heavy allocation in high-yield sovereign bonds, though gains were trimmed by the weakness of high-yield bank credits.

High-yield sovereign bonds issued by the Philippines and Indonesia have recorded substantial gains. The sub-indices of the ADBI returned 2.1 per cent for the Philippines and 2.6 per cent for Indonesia in October with average spreads four basis points and nine basis points tighter respectively. Moody's has lifted the credit rating of the Indonesian sovereign to BA3 with a stable outlook, following S&Ps' Standard and Poor's BB-/Stable and Fitch's BB-/Positive.

However, HSBC's report also expects financial participants including traditional bond investors - such as local banks, asset managers, insurance companies and pension funds and regional fund managers - and hedge funds to take a cautious approach to providing market liquidity following sizeable losses incurred by the industry in recent months.

As a result, HSBC analysts expect a further sharp increase in new debt securities in the coming weeks as issuers fear that the primary credit market might shut down at any moment.

'Even though these new issues will be priced to sell, we fear dropping liquidity, combined with potential negative headline news raising risks, that investors will re-employ wholesale risk reduction strategies to protect profits for the year,' the report noted.

Mr Lee at Barclays Capital believed that another reason for further bonds issued by sovereigns in Asia was to encourage corporates to launch fixed income securities. 'I do believe that the Asian governments will continue to issue for benchmarking purposes to help develop their local corporate bond markets and to soak up excess liquidity in their systems from time to time,' he said.

The Asian Development Bank report noted that while government local currency bond markets grew by 10 per cent in the first half of 2007, corporate bond markets grew slower than most government markets for the first time in 18 months. This is partly due to the rising cost of short-term finance.

Although corporate bond turnover has increased substantially in Hong Kong and China, the increase has been more moderate in Thailand and Indonesia.

But the outlook is bright for Indonesia. Following the merger of the Surabaya and Jakarta stock exchanges which was only scheduled to take effect yesterday, and tax incentives for corporate bond issuers and rules for price discovery have boosted issuer and investor participation in the debt capital markets, according to the Asian Development Bank.

The local currency corporate bond market in Indonesia has increased by 25 per cent this year. In addition, the country is developing a new investor base by launching Islamic bonds which are now worth US$330million. Islamic bonds make up 4 per cent of the corporate bond market.

However, the report released by the Asian Development Bank notes that offshore issuance of sovereign and corporate bonds have been affected by tighter short-term financing conditions (see graphs).

'The continued strains in money markets and some credit markets will likely lead to a tightening of general credit conditions - by increasing costs and reducing funding levels. In major industrial economies such as the US and the eurozone, lending standards have been tightened. There are signs that this could slow GDP growth substantially in these economies, with significant external demand implications for the region,' the Asian Development Bank report notes.