By Sudip Roy
Although fundamentals are still strong, Asian issuance is on hold as the external environment remains fragile
It’s proving to be a stop-start year for Asia’s borrowers. Like other emerging regions, issuance in Asia got off to a relatively strong start. Pakistan, for example, placed a $600 million, five -year Islamic bond in mid January. That was quickly followed by a bold $1.5 billion, 25-year transaction by the Philippines.
Then as spring dawned, Asian issuance dried up as the emerging markets in general took a big hit following renewed concerns about rising interest rates in the US. By April, although the market was inching in the right direction, the outlook remained uncertain. Indonesia’s $1 billion, 10-year bond, for example, which was issued in mid-April, slumped within hours of its launch. At one point the bonds, which carried a coupon of 7.25%, fell to 97.65 from a launch price of 99.127.
Frail
Now bankers and investors are unsure when volumes will begin to pick up again. “Market sentiment is still fragile,” says Dilip Parameswaran, head of Asian credit research at Calyon. “I wouldn’t say that Indonesia will open up the floodgates for everybody else to issue.”
For high-yield borrowers in particular, the market is fraught with danger – as Indonesia illustrated. The spread on the Philippines five-year bond in the credit default swap market, for example, widened to 410bp over US Treasuries at the beginning of April from 325bp before the market sell-off. “High-yield transactions are struggling,” says Frank Kwong, head of syndicate, Asia-Pacific at BNP Paribas.
Even regular, high-grade borrowers are reluctant to test the market. “It would not be the right strategy to try a bond issue in these volatile conditions – the best strategy would be to postpone funding until there is greater stability,” says WG Kim, head of global funding at Korea Development Bank. All eyes are now on this week’s Federal Open Market Committee meeting to see what signals the US central bank sends out.
Another external concern is the falling dollar. So far, according to a report by Standard & Poor’s, the sliding greenback “has had little immediate impact on credit ratings among Asia-Pacific issuers. This is predominantly because the pace of dollar depreciation is gradual, allowing markets and economies to adapt.”
However, S&P warns that: “Dangers lurk from the continuing trend of devaluation of the greenback.” The ratings agency identifies three main risks to credit quality in the region. First, “rising US and Asian interest rates and tightening liquidity could dramatically slow growth.”
Second, “a rapid withdrawal of speculative funds that have flowed into the region would put additional pressure on interest rates and liquidity, threatening asset prices.” Third, and “most drastically, but least likely, is a loss of confidence in the US currency that strains global financial systems.”
Yet despite these risks and the market’s fragility, experts remain optimistic, largely because the fundamentals in the region are sound. Asia has experienced tremendous growth over the past few years, initially fuelled by strong exports. Now, domestic demand is becoming a force in many countries. Asia will grow by 6.5-6.9% this year “on the back of buoyant domestic demand and further strengthening of intra-regional trade”, according to the ADB in its latest outlook report.
Pulling power
This macroeconomic strength is being reflected in the region’s credit fundamentals, both at sovereign and corporate levels. Another recent report by S&P highlights an improving default rate trend in Asia ex-Japan. In short the higher the credit rating, the lower the probability of default. In fact, no corporate default was recorded last year or the year before for rated issuers, says the study.
“The improvement in overall default rates was due to an improvement in general economic conditions, financial restructuring by many issuers, and an increase in the proportion of investment-grade ratings. Investment-grade issuer ratings now comprise 51.5% of all issuer ratings in Asia ex-Japan, compared with 31.4% five years ago,” says the report.
Another of the report’s key findings is that when compared to S&P’s global default database, “the study shows that the cumulative default rates for Asia ex-Japan have been slightly better than those of the global pool.” The report adds that the Asia ex-Japan result is from a relatively small pool of issuers and over a shorter period.
Even so, the conclusions are stark: Asia is an improving credit story, external risks notwithstanding. Many of the region’s sovereigns are investment-grade. And those that are not are more likely to be upgraded rather than the reverse. In addition, despite the sell-off, liquidity in the region remains strong. “Investors are cash rich,” says Rahul Mookerjee, co-head of Asia debt capital markets at Deutsche Bank.
In fact, many Asia borrowers now have a global investor base that they can rely on, assuming stable market conditions. This trend began last year and will continue in 2005, says Mookerjee. “It’s important that issuers can distribute equally to the US, Europe and Asia,” he says. “You need to have all three legs – that’s a healthy development.”