Success of Regional Bond Initiatives

As discussed above, many characterize Asian Bond Markets as “under-developed” relative to other countries' financial systems. One basis for this assessment is the fact that intermediation through bond markets as a share of GDP is far lower in emerging Asia than in major financial centers like the US and Japan. Another reason is that the share of private borrowing is still small relative to the share of government issues, as private firms in Asia still borrow extensively through banks and also raise capital through equity markets. Finally, there is a perception (e.g. Jang and Hyun [2009]) that because of Asia's status as a surplus country in trade, it is generating capital that could profitably be “recycled” within the region, rather than used to finance foreign issues.¹⁰

Asian bond markets also exhibit a diverse set of circumstances. As such, the problems discussed above apply with different intensity across the region. For example, consider the issue of liquidity. Some markets in Asia exhibit greater liquidity and narrower bid-ask spreads (e.g. Jiang and McCauley (2004)). These tend to be markets with larger average issue size. However, the region also contains less liquid markets that exhibit wider bid-ask spreads and higher yields. In particular, the size of local currency bond markets pale relative to their more developed counterparts in the US and Japan.

Another characteristic of Asian bond markets is the small share of private issuance, as corporate financing remained dominated by equity and bank financing. Because the share of private issuance is relatively small, and private issuance tends to be in foreign currencies while public issuance tends to be in local currencies, the share of domestic currency issuance in Asian markets usually exceeds that of hard currency issuance. This feature suggests that private firms in Asia may be “over-banked,” i.e. excessively reliant on bank lending, for their financing. However, as we discuss below, the global financial crisis may warrant a reassessment of the wisdom of using Western standards, particularly those of the past decade, as a benchmark for assessing desirable levels of private issuance in Asia. Moreover, this assessment may be losing its accuracy, as in the case of the PRC where corporate issuance has boomed in the current year.

Indeed, by most accounts, efforts to encourage bond market development in the past decade have been quite successful. Volumes of issuance more than doubled in the region prior to the onset of the global financial crisis, with increased corporate participation and decreasing risk premia. However, the pace of advancement has been heterogeneous across the region. Bond markets in some countries, such as Korea and Malaysia, have achieved corporate market penetration comparable to that in the US (Batten and Szilagyi 2007). However, for other nations, the pace of advancement has lagged.

For example, see Figure 3 [ PDF 74.4KB | 1 page ]. As a share of GDP, the local currency bond markets of Korea, Malaysia and Singapore are most prominent, while those India and Viet Nam are notably lagging behind. To some extent, this discrepancy clearly reflects the relative level of development these countries have achieved. However, it is also interesting to see which countries have succeeded in increasing their local currency bond issues as a share of GDP between 2002 and 2008. Only Korea, Singapore, Thailand, and Viet Nam appear to have made much progress in this area over this period.

While we have stressed throughout that Asian bond markets are quite heterogeneous, and the success of efforts to date to promote bond markets in the region is mixed, some broad generalizations can be made. The first concerns size. It is clear that the regional bond market has grown dramatically since the 1997 financial crisis. It also appears to be the case that Asian bond markets have become more liquid, as evidenced from declines in average bid-ask spreads.

However, a look at the raw size of Asian bond markets (Figure 4 [ PDF 81.8KB | 1 page ]) reveals a much different picture. In value terms, the PRC and Korean bond markets dwarf those of their emerging Asia counterparts. This suggests that for many of these countries, improvements are unlikely to leave many individual markets sufficiently efficient to reach the scale economies necessary to achieve the cost reductions that are adequate to successfully compete with offshore bond markets. Instead, achievement of scale economies is likely to require cooperation at the regional level.

Moreover, the large volumes observed in the PRC are misleading, as the market is dominated by sterilization bonds. Some authors (e.g. Lardy (2008)) have argued that increased issuance of sterilization bonds actually have a negative impact on the development of the PRC bond market, as the need to continue to issue sterilization bonds to pursue its exchange rate goals gives the PRC government an incentive to discourage the development of the rest of the bond market in an effort to maintain low funding costs.

A related question concerns the penetration of local currency bond markets. As a share of total regional issuance, the growth of the local currency bond market has been substantial, as the share has increased from 42.8% at the launch of the ABMI in 2003 to 54.5 % in Q3 2008 (See Figure 5 [ PDF 11.6KB | 1 page ] and Table 2 [ PDF 14.9KB | 1 page ]). Moreover, in value terms the growth has been even more dramatic, as corporate issuance of local currency debt has more than doubled in value over this period while government issuance has almost tripled (see Figure 6 [ PDF 14.9KB | 1 page ] and Table 2 [ PDF 14.9KB | 1 page ]).

Nevertheless, an important reality of the current regional bond market situation is the large remaining holdings of foreign securities as a result of the large global surpluses the region has run vis-à-vis the Western economies, primarily the US. During the same period where the region enjoyed the blossoming of domestic bond market activity just described, holdings of foreign securities, particularly US Treasuries, continued to grow. As a percentage of GDP in the region, US Treasuries peak in our sample in 2007 at 26.9%, up from 19.6% in 2003 (see Figure 7 [ PDF 12.4KB | 1 page ]).

Figure 8 [ PDF 11.5KB | 1 page ] displays foreign securities holdings both within and outside the Asian region.¹¹ It can be seen that holdings of securities issued in other Asian nations grew dramatically within the region between 2003 and 2007, from US$25.0 billion to US$48.5 billion. However, those holdings were not sufficient to close the gap on holdings of securities issued outside the region, which grew over the same period by 52% from US $212.0 billion to US $322.3 billion.

Similarly, Figure 9 [ PDF 11.8KB | 1 page ] reports the overall shares of holdings both within and outside the region. Again, it can be seen that the share of foreign holdings from within the country group increased by a substantial amount, from 10.5% to 13.1% from 2003 to 2007. Still, this only resulted in a modest reduction in the share of holdings from outside the region, which only declined from 89.5% to 87.0%.

Table 3 [ PDF 9.1KB | 1 page ] documents holdings of foreign securities within and outside the region by country. Notable advancement in the shares of within-region investment by such countries as Thailand and Singapore over this period can be seen. However, these shares are still small relative to the share of the region in GDP, and region-wide the declining share of holdings by Korean investors from within the region has largely offset most of these other gains.

Finally, we revisit the issue of the systematic discrepancies between global and regional credit rating agencies that many claimed existed at the launch of the ABMI. To a large extent they no longer seem to exist. For example, see Table 4 [ PDF 10.1KB | 1 page ]. We compare the long-term sovereign debt ratings of nine Asian nations by global ratings agency Standard & Poor's (S&P) and Japanese ratings agency Risk and Investment (R&I). It can be seen that foreign currency ratings by R&I in 2000 were generally modestly higher than those given by S&P. However, consider current ratings by both agencies. If anything, S&P ratings of both local and foreign currency bonds tend to be higher, with a small number of exceptions.

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