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Treasury & Capital Markets
Emerging East Asia LCY bond market growth decelerates
China slowdown, rising interest rates and heightened economic uncertainties impact issuances
Chito Santiago 28 Nov 2022

The growth in emerging East Asia local currency (LCY) bond market moderated in the third quarter of 2022, rising 2.3% to US$22 trillion from the previous three months. This was slower than the 3.1% increase recorded in the second quarter as the expansion in both the government and corporate bond segments slackened.

According to the latest issue of Asia Bond Monitor published by the Asian Development Bank (ADB) on November 25, the slowdown in the China bond market was the main reason for the deceleration. Rising borrowing costs and heightened economic uncertainties also impacted the market as most regional central banks raised their policy rates to fight inflation and in response to the aggressive monetary policy tightening by the US Federal Reserve.

Rising US interest rates and the negative market sentiment also led to portfolio outflows from the region, according to ADB. Regional equity markets recorded aggregate net outflows of US$5.6 billion during the review period. The largest net outflows were noted in China amounting to US$7.8 billion, amid a negative economic outlook due to uncertainties related to measures to contain the spread of Covid-19.

Portfolio outflows were also observed in most regional bond markets in September as the accelerated US monetary tightening not only softened investment sentiment towards risky assets but also made yields on regional bonds relatively less attractive.

Bleak outlook

The risk outlook for regional financial conditions remained tilted to the downside. In the short term, says ADB, the region faces a bleak economic outlook and uncertainties over a larger-than-expected slowdown in China, continued global inflationary pressure, aggressive monetary tightening both globally and domestically, and greater-than-expected fallout from the Russian invasion of Ukraine.

Over the medium term, during the transition of some regional economies to net-zero emissions, the financial sector in emerging East Asia will be challenged by asset vulnerability, especially in high-emitting sectors that could experience higher cash flow uncertainties, increased financing costs and stranded asset issues.

The aggressive monetary tightening in advanced economies has pushed bond yields and worsened financial conditions in emerging East Asia, ADB points out. Regional currencies fell against the US dollar, equities declined and risk premiums widened between August 31 and November 4.

“Financial conditions in emerging East Asia weakened at a faster pace in September and October than in the first eight months of 2022 due to the aggressive tightening by the US Fed,” says ADB chief economist Albert Park. “However, the region remains largely resilient so far, despite various headwinds.”

Government bonds continued to dominate the emerging East Asia LCY bond market. At the end of September, outstanding government bonds reached US$14 trillion and accounted for 63.6% of the regional bond market size. Issuance of government bonds in the third quarter totalled US$1.4 trillion, contracting by 4.5% quarter-on-quarter as some governments had already fulfilled most of their annual financing requirements.

The regional corporate bond issuance, on the other hand, grew faster during the same period at 5.7% to US$800 billion, largely driven by Chinese companies whose issuance rose 7.2% as they took advantage of monetary easing measures designed to stimulate economic recovery.

The corporate bond issuance in the Asean member-economies shrunk 2% in the third quarter of 2023 on the back of rising interest rates and a bleak economic outlook.

Sustainable bonds

The dimming economic prospects and monetary tightening in both regional and global markets also weighed on the sustainable bond market in Asean+3 economies in the third quarter of the year, with the growth rate in outstanding volume moderating to 1.7% to reach US$521.6 billion, compared to the 5% rise in the second quarter.

This comes as the sustainable bond market in Asean+3 witnessed improved diversification in terms of market profile and bond types. The sustainable bond market in the region has significant potential for increased issuance from the public sector, more long-term bonds and more offerings in local currencies.

Meanwhile, the aggressive monetary tightening by the US Fed and other major central banks to fight inflation also underpinned the decline in foreign holdings of LCY government bonds in a number of emerging East Asia markets. The rise in US treasury yields and the strengthening of the US dollar continued to impact the foreign demand in regional bond markets, notes ADB, particularly in the month of September.

The foreign holdings in Malaysia’s LCY government bonds fell to 23.3% in the third quarter of 2022 from 24.1% in the previous quarter – though it continued to have the highest foreign holdings’ share in the region. In Indonesia, the decline was from 16.1% to 14.3% during the same period.

A reversal in sentiments, though, was noted in China with the LCY government bonds posting marginal net inflows of US$500 million as foreign investors returned to the market in July. The inflows were largely due to an improvement in domestic bonds’ negative interest rate differential with the US treasury yields, which declined during the month.

In South Korea, the domestic government bond market also saw net inflows of US$500 million in the third quarter of 2022, slightly higher than the US$300 million inflows posted in the second quarter.

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