Banks and companies have already sold $195.8bn of local currency bonds in Asia ex-Japan so far this year, according to data from Dealogic (excluding auctions, money market transactions, and some other deals). That is a 44.28% jump from the $135.7bn sold over the same period last year.
This expansion of the region’s debt markets has had a big helping hand from foreign investors. They have flooded into Asian markets this year. India, Malaysia, South Korea and Thailand have generated around $17.9bn of foreign investor flows into their bond markets between them, according to data from HSBC. The majority of this has gone into the government bond markets.
The big driver of foreign fund flows into Asia is the expectation of currency appreciation, which in turn is usually driven by predictions of interest rate hikes. That makes noise coming from the region’s central banks a good gauge of likely volumes by the end of the year. The problem is, Asian central banks are not in a hawkish mood. You can forget about rate hikes, the real question is about cuts.
Analysts reckon that there will be no more rate cuts in China, the Philippines and Thailand before the end of the year (although Chinese officials may choose to drop the bank reserve requirement). Indonesia and South Korea also seem likely to hold rates for a while, although weakening data could force their hands. But India has plenty of reason to cut rates further even after its 50bp move last month, and Malaysia is likely to cut rates before the end of the year.
That could turn off foreign investors, damaging the stellar growth of Asia’s bond market seen so far this year. Sabyasachi Mitra, a senior economist at the Asian Development Bank, warned EuroWeek Asia last week about the risk of foreign investors dumping their holdings of Asian local currency bonds. In some places, that is already happening.
Around $683m has been pulled out of Indonesian bonds by foreign investors so far this year. In many ways, that comes as little surprise. Foreign investors have long made up a big percentage of the investor base in Indonesia, holding more than a quarter of overall outstanding bonds since early 2010. That jumped above 30% at the end of 2011, but after the outflows this year, has now fallen to around 26.80%, according to HSBC.
But Indonesia is not the only country with a big chunk of foreign investment in its local bond market. Foreign buyers held more than 25% of Malaysian bonds at the end of last year, and now make up around 32% of the market. Foreign investors in South Korea hold 16.9% of bonds; in Thailand they hold 7.5%. These may not been mind-blowing figures, but they are certainly big enough to have a big impact if foreign investors start to pull out.
This could be the year where Asian local currency markets really come into their own. Fast-growing debt issuance across Asian currency markets is helping to deepen the funding options for the region’s companies, and promote the growth of regional banks. But it's still fragile: a spate of rate cuts could knock it all on the head, and send Asian currency volumes into a tailspin.