Recent Developments of Asian Bonds
By Wilbert OUYANG, August 12th 2011
The Need for a Balanced Asia Financial Market after 1997 crisis
The idea to develop a deep and liquid Asia Bond market gained prominence after the l997 Southeast Asian financial crisis. Analysts generally agreed that the local business was too dependent on indirect financing of banking credit. The “double mismatch” problem, namely currency and maturity risk, was one important factor behind the crisis.
Even though one basic function of banks is maturity transformation, the maturity management remains one big headache for bankers. Ideally, commercial banks should primarily be making short-term loans, as their liabilities are largely demandable short-term deposits (especially true for Asian banks). Banks are not well suited to finance long-term investments on a large scale, although maturity mismatches could be ameliorated by artful asset-liability management and prudential regulation. The maturity mismatch makes banks more vulnerable to crisis, which often tend to be systemic. The 1997 Asia crisis is a good illustration. By then, Asian corporates borrowed heavily short-term funds from commercial banks in foreign currency for long-term domestic investments. When the crisis knocked, these corporate borrowers were unable to borrow fresh capital for their outstanding investments. As default cases increased, the investors were panic to get their money out, naturally local currencies depreciated and the credit quickly dried up. So the corporate sector went busted.
Those countries including Thailand, Indonesia and Malaysia were hit the hardest, which generally lacked well-developed capital markets, and their corporate external financing were mainly bank loans. Therefore financial risk was concentrated in the banking system. The double mismatch risk could be reduced if more corporate borrowers financed their needs through well-diversified portfolios, particularly through bonds. This called for the development of sound and sustainable bond markets in Asia. The corporate sector can borrow for longer maturity periods in local currency, which matches their investment needs and thus enables them to avoid balance sheet mismatches. This also reduces the currency mismatch, another source of vulnerability of a financial system. Therefore, there was a growing consensus in Asia after 1997 crisis to build greater balance in the financial sector through the development of robust local bond markets.
Additional Impetus for Asian Bond Market
The global financial crisis further stressed the importance of developing a full-fledged local bond market to provide funding. Investor uncertainty caused capital outflow from most Asian economies. As the crisis deepened, foreign banks found it necessary to withdraw investments from Asia, thus Asian corporates was facing severe constraints in securing foreign and local currency financing.
Furthermore, Asia needs to mobilize a large amount of capital to finance its huge infrastructure need. The financing need for Asia’s infrastructure was estimated at around US$750 billion per year during 2010–2020. Infrastructure projects are usually long-term in nature. The funding thirsty used to be satisfied through credits through private loans as well as foreign governments and international institutions such as World Bank and Asia Development Bank. With the further development of Asian economies, there could be others financing resources. In 2009, the total annual savings of the 11 major Asian economies was approximately US$3,390 billion, while the stock of total foreign exchange reserves reached US$4,686 billion . At present, a large portion of these savings is invested in markets of developed economies at a low return. Given this huge requirement, one solution could be Asia’s large savings and international reserves. This huge financial resource can be channeled towards long-term infrastructure projects and other productive investments through bond markets.
Strengthening, integrating, and deepening local bond markets, particularly in local currencies, can play a significant role in mobilizing the required funds for enhancing regional demand. Output correlation among Asian economies, for example, has turned from being negative in the early 1990s to average 0.5–0.75 since 1997 (which is now comparable to that of European Union economies). Those investments will not only stimulate domestic economies but also enhance regional connectivity and integration, thereby rebalancing Asia’s growth away from high dependence on exports to advanced economies, such as the United States and the European Union.
Both the crisis experience and the new reality require the development of local currency bond markets in Asia. Asian bond markets can provide alternative sources of financing for public and private investment and alternative modes of wealth holdings for Asian households. This is very important for Asian economies which are gravely in need of both viable funding schemes for infrastructure and capital investment and attractive options for retirement financial arrangements and pensions in a rapidly ageing society.
Besides, Asian bond markets can make the local financial system more resilient. Rather than relying solely on international capital markets, Asian bond markets can facilitate direct mobilization of Asian savings for Asian long-term investment in local currencies. Asian bond market development can reduce currency and maturity mismatches. With the development of local bond markets, the healthy competition between banking sector and bond market will achieve greater diversification of financial risks and make the whole system more sustainable.
Finally, mobilization of Asian savings for Asian investment can contribute to the reduction of global payments imbalances. Well-developed, liquid, transparent local currency bond markets can help mitigate the “information asymmetry” that exists between investors and borrowers by identifying bankable projects and right investment opportunities in the region for potential investors. This would require the creation of a more robust financial system that facilitates information transparency, price efficiency, and legal certainty.
What is Asia Bond?
The term bond in this note refers to bonds and notes with a maturity greater than one year. Bond markets can be classified according to maturity, interest payment schedule, types of issuers, or other details. For instance, the Bank for International Settlements (BIS) categorizes bonds by residence of issuer, targeted investors and currency of denomination by (cf. Table 1).
Table 1: Classification of BIS Securities Statistics
Currency Targets Issuers
Domestic currency Resident investors Domestic Foreign
Non-resident investors Offshore Offshore
Foreign currency Any investor International International
Domestic bonds cover issues by residents targeted at resident investors denominated in domestic currency. Issues by non-residents targeted at resident investors and denominated in domestic currency are part of the foreign bond markets, which go by various colorful names (Yankee for United States, Samurai for Japan, Bulldog for the United Kingdom, Panda for China and Kangaroo for Australia). Offshore (or “euro” in the old sense) markets involve targeting investors with bonds not denominated in their domestic currency. The combined foreign bonds and offshore bonds could be grouped under the title of International bonds.
We will define Asian bonds by residence of issuer. They are interest bearing obligations of Asian governments, financial institutions or corporations, wherever marketed and in whatever currency of denomination. In this connect, Asia bond is determined by the value of Asian currencies and issued and traded in the Asian region’s debts markets. Most of the supply side of Asia bond from Asian economies, and its demand side from the Asian economies as well as global investors. Asia bond market refers to the Asia bond issuance, trading and distribution market. As a regional bond market for some time, the Asia bond market has increasingly become one of the ideal platforms for Asian economies, especially East Asian economies to strengthen regional financial cooperation.
Initiatives for Developing Asian Bond Markets
Ever since the 1997 financial crisis, Asian economies have taken various initiatives for developing bond markets in Asia. The major regional initiatives are highlighted below.
I. Asia Bond Market Initiative (ABMI)
In June 2002, Thailand proposed the conception of the Asian Cooperation Dialogue (ACD), a mechanisms to focus on regional economic cooperation. In June 2003 the second ACD Foreign Ministers’ informal meeting adopted Chiang Mai Initiative, the initiative to develop the Asia bond market, including joint issuance of bonds by Asian countries, measures to promote bonds dominated by national currencies or a basket of Asian currencies, establishment of regional credit guarantee mechanisms, and setting up foreign exchange reserves of Asian countries dedicated to investing in Asia bonds and other recommendations.
Under this mechanism, Thai Government is encouraging all ACD members to issue local currency-denominated Asia Bond to promote the Asia bond market development. In 2004, Thailand’s Ministry of Finance issued in batches some 30 billion U.S. dollars of Baht-denominated sovereign debts, and urged transnational corporations and international agencies to issue Thai Baht-denominated bonds through tax concessions and other preferential treatment to expand the Asia bond circulation. China has been the Asia bond Market Development Initiative active advocate. In 2005, China allowed eligible international development organizations to issue RMB Bonds (Panda bonds) in domestic market.
II. The Development of Asset Securitization and Credit Guarantee Markets Initiative
The initiative was raised by Hong Kong, China in September 2002. It aims to enhance the development of the regional asset securitization and credit guarantee markets through the establishment of expert groups to carry out policy dialogue and discussions and other activities. South Korea, Thailand and the World Bank have joined as co-leaders.
Under the initiative, three working groups have been established in China, Thailand and Mexico, and two policy dialogue seminars have been held. There were six field research investigations to the three participating countries. Suggestions for improvement of the development of asset securitization and credit guarantee mechanism has been forward to the relevant countries for, and related research was submitted in September 2004 to Asia-Pacific Economic Cooperation (APEC) Finance Ministers’ Meeting in Chile.
III. Asia Bond Fund (ABF)
The Executives’ Meeting of East Asia-Pacific Central Bank (EMEAP) is a regional international financial organization with 11 members (including China, Hong Kong, Indonesia, the Republic of Korea, Malaysia, Philippines, Singapore, Thailand, Australia, Japan and New Zealand). With the objective of facilitating bond issuance, EMEAP is working to stimulate from the demand side of this market mainly through the establishment of Asia Bond Fund.
In June 2, 2003, EMEAP announced the establishment of the Asia Bond Fun-1 (ABF-1) with the total amount of l billion USD under the management the Bank for International Settlements (BIS) and the proceeds was now fully invested in investment-grade US dollar-denominated bonds issued by sovereign and quasi-sovereign issuers in EMEAP economies.
Starting from April 2004, EMEAP worked to launch the Asia bond Fund-2 (ABF-2) to be invested in local currency denominated bonds in the Asian region. In December 16, 2004, EMEAP announced the launch of Asia Bond Fund II. ABF-2 was mainly funded by reserves from member states and its size was about 2 billion U.S. dollars, including two parallel funds, namely the Pan-Asian Bond Index Fund and the Fund of Bond Funds. Pan-Asian Bond Index fund was a single bond fund index investing in local currency bonds issued in eight Asian economies, while the Fund of Bond funds was a parent fund investing in eight sub-funds.
Compared with ABFl, ABF2 made significant progress, its sized increased from one billion US dollars to 2 billion US dollars; investment targets expanded from in US dollar-denominated sovereign and quasi-sovereign bond issuers in eight economies to local currency bonds issued by sovereign and quasi-sovereign issuers; the principle of opening to the private sector has been confirmed.
The establishment of a unified bond funds can gradually boost the reputation of the Asia bond market as well as the investment attractiveness of the entire region. This process of continuous improvement in national bond markets along with enhancing participations of regional member states, can promote the formation of an effective credit system in Asia.
IV. The Asia Bond Market Development Initiative (ABMI)
Since 2003, ASEAN, China, Japan and the Republic of Korea (10+3) member states decided to integrate those initiatives and put forward a unified “to promote the Asia bond Market Development Initiative” (ABMI), which will cover the above-mentioned initiatives. ABMI aims to develop efficient and liquid local currency denominated bonds markets in Asia as well as to enable better utilization of Asian savings for Asian investments. It would also contribute to the mitigation of currency and maturity mismatches in financing. Activities of ABMI focus on the following two areas:
1. Facilitating access to the market through a wider variety of issues;
2. Enhancing market infrastructure to foster bond markets in Asia
In August 2003 in Manila, the sixth “10+ 3” meeting of finance ministers formally decided, under ABMI, to establish six working groups from different areas to promote the Asia bond market development. The six initially created working groups later reorganized these into 4 working groups and 2 support teams. Currently the 4 working groups are focusing on:
• Issuance of new securitized debt instruments;
• Establishment of a regional credit guarantee agency;
• Exploration of possible establishment of a regional settlement and clearance system;
• Strengthening of regional rating agencies.
Under the wave of the economic globalization, it remain a topic of common concern for Asian economies to maintain the region’s financial stability and economic security, which also lays a solid foundation for the development of Asia bond markets. From an economic point of view, Asian economies have been forging an ever closer economic entity, which has laid a good foundation for the Asia bond market development. At present, many Asian economies have made substantial progress in the Asia bond market development. From the second half of 2004, Malaysia, Thailand and other countries have allowed issuance and transactions of cross-border bonds in the domestic markets. Thus, the Asia bond market has good prospects for development.
Current Status of Asian Bonds Markets
As shown in table 2, the developing Asian financial market also remains financially underdeveloped relative to the advanced economies . The figure compares financial development, as measured by total liquid liabilities, bank credit, stock market capitalization, and bond market capitalization—of some major developing Asian countries with that of high-income OECD countries. In particular, the region’s bond markets are the least developed. However, the situation is under significant improvement with exponential volume increase in local bond market (cf. table 3). During the period from 1997 to 2010, the total volume of local bond market has risen from US$405.31 billion to US$5210 billion, an increase of 12 folds. The size of government bond market has been grown even faster, up 2,256%. By end of 2010, the Asian bond market was dominated by Government debts, comprising 68.91%. The fast expanse of Asian bond market stems from official measures to develop local currency bond markets, including regional efforts such as the ABMI and the Asian Bond Funds.
Table 2: Financial depth, selected Asian and OECD countries, 2008
(% of GDP)
Economy Overall financial markets and banks Capital markets
Liquid liabilities bank credit Stock market Bond market
China 150.0 104.2 80.6 48.7
Bangladesh 57.5 35.9 11.1
India 73.2 47.8 173.2 34.3
Indonesia 38.0 22.8 55.3 19.9
Pakistan 46.9 27.5 45.1 26.9
Philippines 53.2 22.1 76.3 32.3
Thailand 91.5 78.1 73.3 56.7
OECD 113.3 127.8 119.2 108.1
East Asia’s capital controls and regulations have been relaxed gradually but they remain a major obstacle impeding capital movement within the region. Capital controls and regulations create distortions in international capital flows. They often take the form of restrictions on foreign financial institutions entering the domestic financial market or a cap on foreign equity ownership in domestic financial institutions. Such restrictions have long since been removed in more mature economies such as Japan, Korea, Hong Kong and Singapore, but many East Asian countries still control capital flows in many ways.
Table 3: Size and Composition of Local Bond Markets in Asia
Unit: USD billion
1997 2004 2005 2006 2007 2008 2009 2010
China 116.40 527.70 899.24 1,184.12 1,689.83 2,213.00 2,567.00 3,052.00
Government 67.40 331.80 835.18 1,078.57 1,533.12 1,957.00 2,113.00 2,408.00
Corporate 49.00 195.90 64.07 105.55 156.71 256.00 454.00 644.00
Hong Kong 45.78 78.24 85.59 96.19 97.98 88.00 144.00 164.00
Government 13.12 15.78 16.34 16.94 17.52 20.00 70.00 87.00
Corporate 32.66 62.46 69.25 79.25 80.46 68.00 74.00 77.00
Indonesia 4.60 57.70 54.15 76.72 87.55 68.00 99.00 106.00
Government 0.90 50.80 48.27 69.88 79.14 61.00 89.00 94.00
Corporate 3.70 6.90 5.88 6.84 8.41 6.00 9.00 13.00
South Korea 130.37 567.70 983.53 1,192.72 1,313.81 817.00 1,016.00 1,149.00
Government 21.60 170.50 583.07 702.88 722.11 368.00 444.00 492.00
Corporate 108.77 397.20 400.45 489.84 591.69 448.00 572.00 657.00
Malaysia 57.00 110.70 106.70 121.38 164.16 163.00 185.00 247.00
Government 19.40 47.30 52.25 61.00 88.61 89.00 101.00 145.00
Corporate 37.60 63.40 54.45 60.37 75.55 74.00 84.00 101.00
Philippines 16.92 35.30 41.66 46.36 58.02 59.00 63.00 73.00
Government 16.60 35.00 40.20 43.50 52.84 53.00 55.00 64.00
Corporate 0.32 0.30 1.46 2.86 5.18 6.00 8.00 8.00
Singapore 23.77 79.39 83.10 99.39 118.11 129.00 141.00 179.00
Government 13.05 44.02 46.90 55.92 68.13 73.00 88.00 103.00
Corporate 10.73 35.37 36.20 43.47 49.98 56.00 53.00 76.00
Thailand 10.47 68.00 78.84 112.01 153.93 143.00 177.00 225.00
Government 0.30 36.20 54.29 74.58 107.47 114.00 141.00 183.00
Corporate 10.17 31.80 24.55 37.44 46.45 28.00 36.00 42.00
Viet Nam 0.00 3.78 4.30 4.93 9.79 129.00 12.00 15.00
Government 0.00 3.78 4.20 4.50 8.28 124.00 11.00 14.00
Corporate 0.00 0.00 0.11 0.43 1.51 5.00 1.00 2.00
Emerging East Asia 405.31 1,528.51 2,337.11 2,933.82 3,693.18 3,809.00 4,404.00 5,210.00
Government 152.37 735.18 1,680.70 2,107.77 2,677.22 2,859.00 3,112.00 3,590.00
Corporate 252.95 793.33 656.42 826.05 1,015.94 947.00 1,291.00 1,620.00
The credit rating might also be a contributing inhindrance for the full development of local bond market. As shown in Table 4, up to now, the sovereigns rating for some Asian economies are still below investment grade (below BBB-). For instance, Indonesia gets BB+; Viet Nam gets BB-, while Philippines manages to get BB. Lower sovereign ratings will to some extent deter investors’ enthusiasm in local market. In addition, there are only a limited number of large, reputable firms which can issue high-rated bonds. Corporate governance of family-controlled companies and the emphasis on the expansion of capital through business profits or bank loans tend to discourage raising through direct financing. That helps to explain the faster growth of government bonds in recent years.
Table 4: Standard& Poor’s Sovereign Ratings List for Asia Economies
As of August 11th 2011
Economy Foreign Rating Economy Foreign Rating Economy Foreign Rating
China AA- Singapore AAA Viet Nam BB-
Korea A Indonesia BB+ India BBB-
Hong Kong AAA Thailand BBB+ Japan AA-
Malaysia A- Philippines BB Pakistan B-
Another factor could play in some role, that is, institutional investors in East Asia are largely underdeveloped. Most of the pension funds, mutual funds and insurance companies are small and incapable of expanding their cross-border portfolios. Institutional investors are in their early stage of development in most East Asian countries. Some Asian countries have established sovereign wealth fund (SWF). For example, Singapore has a well established Temasek, and China set up the China Investment Corporation (CIC). Those SWFs could be potential investors into local bond markets. To further boost the development of bond market, further policy initiatives, such as Asian Funds Passport, should be established.
Last, risk-averse behavior by regional investors is another factor limiting capital movement within East Asia. The increase in accumulated foreign exchange reserves is creating a situation that structurally forces East Asian countries to manage their assets safely. East Asia’s relatively weaker capability to evaluate and manage risks also discourages East Asian investors from taking risks.
Asia delivered a strong performance during the global financial crisis, however decades of bank-dominated financial intermediation has left local financial systems still underdeveloped. Complex institutional and regulatory frameworks have limited the scope further for expanding growth continually. A more balanced and modern financial systems would facilitate developing Asian economies to go farther in their quest for a higher-growth path.
Initiatives to develop Asia bond markets could include: sustaining a stable macroeconomic environment with low inflation and stable interest rates, developing a healthy government bond market that would serve as a benchmark for the corporate bond market, promoting the growth of regional bond market centers, improving corporate governance, strengthening the regulatory framework for bond market, and broadening the investor base. A regional credit guarantee scheme could further boost the overall appeals of Asian bond market, which should give a serious consideration. Since at present there is a great diversity in the levels of bond market development across countries, significant country-specific deciphering of these requirements will be needed for developing country strategies for bond market development.
Asia Development Bank: Asian Development Outlook 2010 Update
Asia Development Bank: bond market development in East Asia: issues and challenges
Asia Development Bank: Asia Bond Monitor March 2011
Bank for International Settlements: Local Currency Bond Market and the Asian Bond Fund 2 Initiatives, 14 July 2011
Bank for International Settlements: Asian Bond Market: Issues and Prospects, Nov 2006
Masahiro Kawai: Asian Bond Market Development: Progress, Prospects and Challenges, Keynote Address at High Yield Debt Summit Asia 2007, 16-17 May 2007
Committee on the Global Financial System: Financial stability and local currency bond markets, CGFS Papers No 28, June 2007
Asian Development Bank Institute, Bond Market Development in Asia: An Empirical Analysis of Major Determinants, ADBI Working Paper Series, July 2011