ADB on the Impact of the Bond Vigilantes on Asian Bonds

From the Asian Development Bank (ADB): (bold mine)

At the end of June, there were $6.8 trillion in local currency bonds outstanding in emerging East Asia, which is comprised of the People’s Republic of China (PRC); Hong Kong, China; Indonesia; the Republic of Korea; Malaysia; the Philippines; Singapore; Thailand; and Viet Nam. That was 1.7% more than at the end of March, but a slower growth rate than the 2.9% expansion seen in the first quarter of 2013 with investors now more cautious in the wake of the May announcement from the US Federal Reserve that it will soon start reducing its bond purchases.

Local currency bond issuance also continued in emerging East Asia, but still at a slow pace as some borrowers held back in the face of higher funding costs around the region. There were $827 billion in new bonds sold between April and June, 4.0% more than in January through March, largely thanks to a 26.8% increase in issuance by central governments and agencies. Corporate issuance slumped 20.1% quarter-on-quarter to $168 billion as new bond sales by PRC companies tumbled 48.8%. Excluding the PRC, corporate issuance ticked up 1.4%.

Turmoil in the global financial markets has also made it harder and more expensive for emerging East Asian companies, particularly lower-rated firms, to borrow in the key foreign currencies – US dollars, euros, or yen. After $81 billion in issuance in the first five months of 2013, June and July saw a total of just $7.5 billion raised.

Compared with 1997-1998 when Asia suffered a financial crisis, governments and companies now hold more of their debt in local rather than foreign currency and the debt is now longer-dated than it was, meaning they are less vulnerable to currency depreciation and sudden shifts in borrowing costs and investor appetite.

But domestic sourcing of ballooning debt is an illusion of stability. Increasing accumulation of debt are symptom of bubbles regardless the currency configuration of the debt structure.

As Harvard’s Carmen Reinhart and Kenneth Rogoff pointed out (bold mine)

This brings us to our central theme—the “this time is different syndrome.” There is a view today that both countries and creditors have learned from their mistakes. Thanks to better-informed macroeconomic policies and more discriminating lending practices, it is argued, the world is not likely to again see a major wave of defaults. Indeed, an often-cited reason these days why “this time it’s different” for the emerging markets is that governments there are relying more on domestic debt financing.

Yet the preliminary impact on bond returns

Market returns on Asian bonds have fallen sharply so far this year with the iBoxx Pan Asian Index falling 3.5% in US dollar, unhedged terms. Losses were largest in Indonesia, down 17.8% and Singapore, down 7.8%. Only the Philippines and the PRC markets saw gains of 7.5% and 3.1% respectively.

I say preliminary because should the onslaught of the bond vigilantes continue, expect this to be a global contagion. Expectations of decoupling-insulation will be eventually exposed as grand delusions.