ADB says East Asian bonds face risk of capital exit in crisis

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East Asian bond markets, which are outperforming developed nations, face the risk of a capital exit should an event such as the US fiscal deficit trigger a recession, according to the Asian Development Bank.

Regional policy makers need to increase efforts to shield their economies from another crisis even after doubling the pool of combined foreign-currency reserves to $240 billion as of May, Iwan Azis, head of the ADB's integration office, said before the release of the Asian Bond Monitor today. The US budget issue threatens a recovery and an agreement in Congress that doesn't address the long-run sustainability of the deficit may not be welcomed, the Manila-based lender said in the report.

A volatile debt market and swings in yields may deter both bond issuers and international investors, who raised holdings of fixed-income securities in the region last quarter, Azis said in an interview from Jakarta yesterday. Asian local-currency notes have returned 8.4 percent this year, compared with 2.1 percent in the US and 7.1 percent among European countries, according to indexes compiled by HSBC Holdings Plc and Bank of America Merrill Lynch.

"Capital flows continue to grow in Asia but at the same time they are getting more and more volatile," Azis said. "The bond market is now the most important source of financing for many Asian countries."

Asia "˜vulnerable'

Overseas holdings of local-currency debt in some East Asia emerging markets, which the ADB terms as China, Indonesia, South Korea, Malaysia, the Philippines, Singapore, Thailand and Vietnam, rose last quarter, the multilateral lender's bond report showed.

Ownership in Indonesia increased to 29.7 percent of the nation's total as of the end of September from 28.4 percent in June, while in Thailand the proportion climbed to 15 percent from 13.2 percent and to 28.5 percent from 27.1 percent in Malaysia, according to the ADB.

During the height of the European debt crisis in 2011, funds based abroad cut holdings of Indonesian government bonds by an unprecedented 29 trillion rupiah ($3 billion) in September of that year, finance ministry data show.

"Some Asian bond markets are relatively small still and if you have a small market but ownership is mostly foreign investors, then you'll be vulnerable to any shock like what happened during the euro-zone crisis in 2011," Azis said.

Crisis defense

Asian policy makers will have to be vigilant by adopting so-called macro-prudential measures in terms of managing foreign reserves, inflation, current accounts and fiscal balances as they will have to defend themselves from any global crisis, Azis said. The divided US Congress has to strike a deal before the so-called fiscal cliff of automatic tax increases and spending cuts are due to start in the first three months of 2013.

Finance ministry and central bank officials from Japan, China, South Korea and the 10-member Association of Southeast Asian nations agreed on May 3 to boost their foreign-currency reserve pool to $240 billion under the Chiang Mai Initiative Multi-lateralization agreement. The Asean+3 countries also set up a precautionary credit line to prevent another crisis.

Under the initiative, the countries can draw as much as 30 percent of their allotment from the fund, while they would have to seek the remaining 70 percent from the Washington-based International Monetary Fund.

`The stigma'

During the Asian financial crisis, the IMF loaned more than $100 billion to Indonesia, Thailand and South Korea, and governments were forced to cut spending, raise interest rates and sell state-owned companies in return.

"That 70 percent has to be reduced as much as possible," Azis said. "The stigma about the IMF is still very strong. We are appealing for a strengthening in the regional safety net. Asia has to rely more on its own regional resources. They have to strengthen the rules and the size of the money."

Outstanding debt in East Asia climbed 11 percent in the third quarter from a year earlier to $6.2 trillion, the ADB report showed. The corporate bond segment increased 17.6 percent to $2.1 trillion, while government securities rose 7.8 percent to $4.1 trillion.

Total sales of local-currency notes in the region declined 4.5 percent last quarter from a year earlier to $826 billion, according to the ADB. Issuance from companies jumped 45.4 percent to $216 billion, while government and central bank debt offerings fell 14.8 percent to a combined $611 billion.

"The continued strong capital flows that the region is experiencing further expose regional markets to contagion risks," the ADB said. "It also raises concern over capital flight risks."

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