Local currency bond markets are key to meeting Asia’s infrastructure needs, if the region is to avoid dangerous currency mismatches while coping with falling bank financing.
But the region will need all the help it can get given the tenors and credit risks involved, delegates told Emerging Markets at the ADB annual meeting in Astana this week.
Bank financing for long term projects is drying up as the new regulatory environment of Basel III comes into force. While infrastructure remains critically important, liquidity is tightening and the large foreign inflows to Asia have supported consumption rather than infrastructure, said Thiam Hee Ng, senior economist with the ADB’s Office of Regional Economic Integration.
“Now that liquidity is going to be tighter we need to rely more on domestic savings to fill the gap,“ he said. “There is great potential for the local currency bond markets to pick up financing.”
Bond issuance will have to be in local currency in order to avoid the maturity mismatch that hit the region hard in the 1997 Asian financial crisis.
“The problem isn’t whether the funds come from onshore or offshore,” Thierry de Longuemar, the ADB’s vice president for finance and risk management, told delegates. “What matters is the currency and how that fits into asset liability mismatch.”
Local currency bond markets in Asia are growing fast, but infrastructure financing offers a very different risk profile to traditional corporate credit. The work involved in analysing and pricing the risk could be difficult for regional investors.
The risks involved in project bonds are significantly higher, making them closer to real estate investment trusts or business trust products and of interest to a very different investor base than that of traditional bonds, Yoshihiro Inoue, Daiwa Capital Market’s head of debt capital markets, told Emerging Markets.
For companies looking to fund infrastructure with traditional bonds, pension funds are natural choices, and in several countries these funds have proved eager to invest in infrastructure projects.
“Malaysia is a good example,” said Hee Ng. “It’s been a pioneer in allowing funds to invest in products other than government bonds.”
The bulk of Malaysian pension funds’ fixed income investments are still in government bonds, but even 5%-10% of holdings going to infrastructure can have a big impact, he said.
“What we’re seeing is that as regional economies develop the need to provide a social safety net for the population grows,” said Hee Ng. Malaysia and Singapore have gone further than others in marrying pension funds with infrastructure finance, but pension funds elsewhere in the region continue to grow, he said. It has helped Malaysia build a thriving ringgit project bond market, where large multi-tranche bonds are common.
But investors can be very conservative moving into such markets and for many borrowers credit enhancement will be necessary. ADB initiatives and guarantee facilities can help smaller issuers without risk ratings tap the market, and others can raise bond ratings to investment grade.
The ADB's Credit Guarantee and Investment Facility, for instance, provides mechanisms to allow corporate borrowers from the Asean countries to issue with investment grade ratings. “We’re also considering an infrastructure fund, which would be specifically targeted at infrastructure financing and provide a vehicle to allow more issuance from Asean,” the ADB’s de Longuemar said.
Nor are efforts to support issuance consigned to public sector institutions. “Infrastructure project bonds is one of the key themes we’re working on globally,” Alexi Chan, HSBC’s head of debt capital markets origination for Asia told delegates. “We’re working with a variety of credit providers to enhance the Asian bond markets.”