Malaysia seen as beacon of hope for Asia bond flows

Malaysia was cited as an example of why regional and global investors have good reason to be optimistic about the development of Asia’s debt capital markets, a conference heard yesterday.
 
On a panel discussion seeking to explore the demand and supply conundrum of Asia’s local and hard currency bond markets – touching on investment risk, liquidity and ease of access – Malaysia was praised for the strides it has taken.
 
“Its regulatory system and attitude towards inward investment has it punching above its weight,” said Geoffrey Lunt, senior fixed income product specialist at HSBC Global Asset Management. “The rest of Asia must be looking at Malaysia and thinking, ‘those guys have stolen a bit of a march on us’.”
 
Speaking at the fourth Asia-Pacific Debt Investor Forum hosted by AsianInvestor and FinanceAsia in Hong Kong, Lunt pointed to Malaysia’s sukuk, or Islamic bond, market by way of example.
 
“Of all Islamic countries to be at the centre of that market, 10 years ago you would not necessarily have chosen Malaysia to be there,” he added. “This competitive environment is good for everyone.”
 
Michael Petit, managing director within Standard & Poor’s Ratings Services, noted that both Malaysia and Thailand had allowed global credit rating agencies to assign ratings to domestic debt issues in the past 12 months, which is not yet the case in China or Korea.
 
“What you need to build good bond markets is an environment where a credit culture is allowed to flourish,” he said, “and that means being allowed to do credit research.”
 
He reasoned that what is needed now is consistency to encourage global participation and help capital flows in the region's bond markets, including mutual recognition agreements, harmonisation of offering standards and relaxation of capital restrictions. 
 
“I agree we should be optimists,” added Petit. “A lot has been done and continues to be worked on by policymakers and private market practitioners.”
 
On the question of risk in Asia’s local and hard currency debt markets, Petit sought to distinguish between credit (default) risk and other factors, such as liquidity and foreign exchange risks.
 
He noted that S&P’s decision to downgrade the long-term sovereign credit rating of the US on August 6, 2011, was based on policy risk rather than any change in fundamentals.
 
In that sense he noted that market-derived ratings for Malaysian debt seemed to have dropped two notches in the past four months, influenced by the political environment as the country prepares to hold elections. “Our rating on Malaysia remains stable.”
 
Sumit Bhandari, director of Asia-Pacific fixed income at BlackRock, suggested the market tended to be better at capturing policy risk and pricing that into the bond yield. 
 
Still, Petit expressed confidence that market conditions would remain benign in the coming year because of easy monetary conditions. He is expecting a slight pick-up in default rates in Asia, although from exceptionally low levels.
 
On the question of demand and supply, Bhandari noted that Asian local currency fixed income as a percentage of global bond portfolios is still small, at around 7%. But he sought to differentiate between government and corporate bond markets.
 
Without a single G3 sovereign issue in Asia this year, there is no supply on the hard currency side; so when it comes to government bonds, local currency is where the liquidity and opportunity set is.
 
But on the corporate credit side, the demand is still in hard currency, though that is not to say it won’t change over time as China and India (eventually) become more vibrant markets, said Bhandari.
 
Hayden Briscoe, director of fixed income for Asia-Pacific at AllianceBernstein, noted that if China did open up it would instantly become the third largest bond market in the world, which by any traditional government index would equate to a 10-12% allocation.
 
So if 7% of global bond portfolios are allocated to Asia, that would mean they would have to allocate north of 10% just to China. “That is a lot of currency buying,” Briscoe said.

He added that what a lot of international investors overlook when it comes to Asia's corporate bond market is that many of these companies are linked to their respective governments.

"[Global investors] miss the intertwined nature of the corporate credit space [in Asia] and how important the sovereign is," he said, suggesting that was why the region had seen much lower default rates post the Asian financial crisis of 1997-8.

Lunt stressed that it is not the raison d'etre of Asian countries to satisfy the needs of global investors and that if they need to take action to limit foreign inflows, they will.

He suggested the opening of Asia's markets was not an end in itself, but part of a process as countries attempt to transition their economies towards domestic consumption.

At the same time he added: "We have to accept that the environment for Asian fixed income over the last 10 years has been extremely benign and there will be crises in this part of the world as there will be everywhere. The sooner we develop these markets, the more robust they will be to that kind of crisis environment."