Asian bond market reflects high investment needs

VIEW FROM HONG KONG

Dismayed by lacklustre gains in Asian stock markets, frightened by the risks of derivatives and generally uncertain about the direction interest rates are heading, many investors in this part of the world are looking with intensifying interest at the growing Asian bond market.

The appetite for funds from fast-expanding Asian nations cannot be denied, nor can the potential for making money from this demand. Yet many international investors still know little about Asian bonds. A recent World Bank conference on Asia's emerging bond markets, held in Hong Kong, set out to rectify this knowledge gap.

Armed with an impressive collection of data, providing the first really comprehensive look at these markets, the World Bank's conclusions were decidedly bullish.

Gautam Kaji, the World Bank's managing director, estimates the region's total investment requirements as totalling almost US$8 trillion over the next decade.

The Bank forecasts a large "shift from the banking system to capital market development, especially the bond market". It emphasises the "massive investment needs of the region, especially for long-term private fixed investment required to sustain the high levels of projected economic growth". These growth levels are combined with a tendency of governments to ask the private sector to look after longer term projects.

Taking such factors into account, and focusing on the East Asian countries most likely to be tapping the international markets for funds, the bank predicts that the East Asian bond market will "most likely cross the trillion dollar mark by 2004, from about US$338 billion at the end of 1997".

The current size of the bond market is equal to some 22 per cent of the region's gross domestic product (GDP), less than a third of the size of the regional equity markets, and represents a mere 2.1 per cent of the global bond market. There is little doubt that the East Asia bond market is relatively underdeveloped.

This is in marked contrast to the standing of the region's stock markets which are at least as well developed, in terms of capital raised relative to GDP, as their counterparts throughout the industrialised world. The total market capitalisation of the eight East Asian stock exchanges amounted to 71 per cent of GDP at the end of 1994 and the banking system of the eight nations had assets equal to 92 per cent of GDP.

Hong Kong and Singapore are clearly vying for regional centre status as the markets develop, with both territories taking measures to boost their attractiveness.

Singapore is in the lead at the moment, with a bond market equivalent to 72 per cent of its GDP, larger than the capitalisation of its stock market. Hong Kong is well behind. In 1993, the bond market accounted for the equivalent of a mere 5 per cent of GDP, mainly because domestic bond issues are so insignificant, albeit rapidly growing. The Hong Kong government realises this is a problem and is busy developing a full range of financial products to ensure the domestic market can offer all instruments available on the international market.

Singapore, meanwhile, is stressing its political stability and attractive tax breaks for the financial sector. It has a uniquely large local savings base drawn from a central provident fund which can be poured into the bond market.

Ninety eight per cent of the bonds issued in the island state are Asian Dollar Bonds. The government remains ambivalent about the internationalisation of its currency and so it is likely that Singapore will continue to be a Asian dollar centre.

By far the biggest demand for investment, particularly infrastructure investment in the region, will certainly come from China, which will need something like half the funds required by the East Asian region as a whole. As matters stand, China is already the world's fifth largest borrower. This change is remarkable. In 1983, China's foreign debt stood at US$9.6 billion, last year it had risen to US$103 billion. Annual foreign debt service charges rose from US$2.7 billion to US$13.6 billion in the same period.

The Chinese market is fraught with problems, which goes some way to explain why the bond market size was equivalent to just 7 per cent of GDP by the end of 1994. Yields in the Chinese bond markets appear to be high, but not in real terms given inflation levels of around 20 per cent.

Moreover, the yield curve in the secondary market is erratic, compared to a more stable environment in other East Asian markets.

In South Korea, for example, which has had a bond market since the 1950s, and is the largest among the East Asian bond markets, the market equates to 43 per cent of GDP and rate yields are very attractive. In the past few years, they have been at least double the rate of inflation.

Foreigners were only allowed to participate in the market last year, but Korea is increasingly keen to participate in the international financial market and is steadily liberalising access to overseas investors.

Thailand has been in the bond market for much longer than most Asian countries but remains one of the smaller issuers. Coupled with this is the fact that its market is of interest both because yields are high and, rather peculiarly, there is little difference in the yields of highly rated bonds and those given a much lower rating. Thailand provides an opportunity for good returns at low risk levels.

Not only will the Asian bond market expand rapidly, but it is likely to change in character. The World Bank expects that, with the exception of China and the Philippines, corporations and state-owned enterprises will emerge as the major bond issuers in the coming decade, taking over from governments.

Domestic sources of investment funds are also likely to come from new sources with the development of social security programmes in the region, alongside the growth of the insurance and mutual fund industries.

The bond markets will become increasingly open to foreign investors. The question is whether foreign investors will be able to recognise the opportunities.

Stephen Vines

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