Introduction

Since the 1997 Asian financial crisis, there has been a perception that Asian financial markets would be aided by the existence of developed local currency bond markets. In part, these perceptions stretch back to former Federal Reserve Chairman Greenspan's “spare tire” argument that bond markets would provide alternative vehicles for intermediation in the event that primary sources of financing, such as bank and equity finance opportunities were disrupted (Greenspan 1999).

While others have expressed skepticism at this argument, it is generally agreed that the absence of well-developed domestic and regional bond markets exacerbated the 1997 crisis by increasing the losses of output and the severity of financial sector distress [e.g. Park and Park (2003)]. At a minimum, it is generally agreed that the opportunity to issue in local currencies would mitigate the currency mismatch difficulties experienced in many Asian nations in the wake of their severe exchange rate disruptions. Indeed, International Monetary Fund (IMF) conditionality requirements for support of some of the distressed Asian nations during the 1997 crisis, for example Thailand, included explicit calls for the development of local currency bond markets (Batten and Hoontrakul 2008).

In response, Asian governments actively undertook initiatives to promote local currency bond finance through their initial Asia Bond Market Initiative (ABMI) and through the Asian Bond Funds 1 and 2 (ABF1 and ABF2). While Asian bond markets have grown markedly since the launch of these initiatives, there is still a perception that the region is underserved by domestic bond markets (e.g. Eichengreen and Luengnaruemitchai [2006]). Moreover, as shown below, the progress to date has been heterogeneous within the region.

In part, the development of local currency bond markets has been hindered in some economies by the lack of sufficient economies of scale, due to insufficient demand for assets denominated in the local currencies of smaller Asian economies. In response, efforts have been made to coordinate policies at the regional level to achieve the scale economies needed for viable bond market activity.

This paper reviews the arguments for intervention in favor of the development of regional bond markets and assesses the progress on these initiatives to date. While it is relatively early to assess the ultimate success or failure of regional efforts to promote the development of their domestic currency markets, it does seem a good time to take stock.

Roughly five years passed between the launch of the Asian Bond Market Initiative and the onset of the global financial crisis. It would seem reasonable to expect some improvement in market liquidity and depth over this period of relatively uninterrupted global expansion, and indeed, it is apparent that much success in deepening markets as a region was achieved. For example, in the first five months of 2009, Chinese companies issued US $82 billion in debt, far outpacing the Japanese US $51 billion in issuance over the same period (Balfour 2009). However, there can be no doubt that the current global financial crisis begs for a reassessment of both the merits of efforts to encourage local currency bond market development and the degree of success that has been achieved to date.

The overall ramifications of the current global financial crisis are still uncertain, but it is clear that this event has challenged our understanding of the functioning of financial markets and their roles in economic activity. In particular, one of the primary motivations for encouraging the developments of Asian bond markets stemmed from the perception that that region was “overbanked,” relative to its Western counterparts. In light of the current turbulence in security and equity markets worldwide, one wonders whether heavy dependence on banks for intermediation is such a bad thing. Indeed, many have argued that Western financial markets are likely to become more dependent on commercial banks in the future. This is demonstrated most dramatically in the United States (US), where many investment banks have returned to conventional banking activities.

On the second issue, the collapse of the asset bubble of the previous decade has revealed that a substantial share of investment during the run-up of the bubble was misplaced, often undertaken in an effort to “chase yields” in an environment of greater and greater risk tolerance. There can be no doubt that some of the capital allocated to Asian emerging market economies falls into this category. This raises the question of what share of the “success” experienced by the region in encouraging bond market investment will be retained, now that the risk tolerance of the boom years has abated.

As such, the current financial crisis provides a good opportunity to reexamine the merits of the Asian bond initiatives. Our analysis suggests that the bulk of policy conclusions one would be likely to have held going into the crisis are still likely to be valid. However, we should be cautious in concluding that the efforts to promote regional bond markets have been an unqualified success. While there is no doubt that the progress to date has resulted in a dramatic increase in local bond market volumes in some countries in the region, there is still much heterogeneity across the region in the pace of market deepening and in the speed of regulatory reforms.¹ Moreover, the crisis itself demands a reassessment of what constitutes a successful domestic bond market. Below, we review these considerations and suggest which policies are likely to remain conducive to the pursuit of successful domestic bond markets going forward, and which now appear to be anachronistic.

The remainder of the paper is divided into six sections. Section two discusses the motivation for intervention in favor of local currency bond market development. Section three discusses regional efforts prior to the global financial crisis. Section four assesses the success of these initiatives. Section five discusses the implications of the global financial crisis for the merits of regional local currency bond market initiatives, and provides an early review of regional policy responses to the crisis. Lastly, section six provides some policy conclusions.

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