The emerging East Asia local currency bond markets demonstrated a steady expansion in the second quarter of 2019, bucking the downside risks stemming from the ongoing trade tension, a faster-than-expected economic slowdown in China, and moderating global growth.

According to the latest issue of Asia Bond Monitor published by the Asian Development Bank (ADB) on September 18, foreign investment in emerging East Asia bond markets, despite the risks, remained stable during the period.

“Foreign investment in emerging East Asia remains stable, but there are still considerable potential risks,” says ADB chief economist Yasuyuki Sawada. “Financial stability in the region could be undermined if global investors change their views on emerging markets. Governments in the region would do well to continue to deepen their local currency bond markets so they can act as a reliable local source of funding.”

At the end of June, the local currency bonds outstanding in emerging East Asia totaled US$15.3 trillion, up 3.5% in US dollar terms compared to the end of March this year and 14.2% higher than the end of June 2018. Bond issuance in the region during the second quarter amounted to US$1.6 trillion, representing an increase of 12.2% from the first quarter due to strong issuance of government bonds and a recovery in the corporate bond issuance.

Government bonds accounted for US$9.4 trillion of the total local currency bonds outstanding as of the end of June, up 13.6% from a year ago, while the stock of corporate bonds amounted to US$5.8 trillion, up 15% compared to June 2018.

China remains the largest emerging East Asia local currency bond market in the region, accounting for 75.3% or US$11.5 trillion of the outstanding paper. The stock of local government bonds rose 5.4% on a quarter-on-quarter basis, following directives for local governments to accelerate the issuance and use of special bonds to support economic growth and finance infrastructure and other development projects. China’s debt-to-gross domestic product ratio at the end of June this year was 84.6%, up from 78.8% in comparable period a year earlier.

South Korea was the second-largest local currency bond market in the region, with outstanding bonds totaling US$2 trillion at the end of June. Growth in government bonds moderated by 1.7% quarter-on-quarter – from 1.9% in the first quarter – on a contraction in the stock of other government bonds and a marginal growth in central bank bonds.

On the other hand, Vietnam’s local currency bond market, with an outstanding volume of US$52.9 billion at the end of June, remained the smallest in the region. Government bonds were the main driver of growth, expanding by 3.2% quarter-on-quarter, spurred by the increase in stock of treasury bonds and central bank bills.

Foreign investor holdings were mostly stable in emerging East Asia local currency bond markets at the end of June, underpinned by the positive sentiment as the US Federal Reserve signaled a possible policy rate cut, which was subsequently announced on July 31.

The foreign holdings’ share rose in China to 5.4% at the end of June from 5.1% in March on expectations the government will provide additional stimulus measures to prop up the economy. Indonesia also saw an increase in the foreign holdings’ share from 38.3% to 39.1% on account of a ratings upgrade from S&P Global Ratings.

Malaysia, though, posted a decline in foreign investor holdings from 23.8% to 22.3% due to investor reaction to news reports that Malaysian bonds would be removed from FTSE bond indices and that Norway’s sovereign wealth fund would drop Malaysia’s bonds from its fixed income portfolio. Lower oil prices also generated investor concerns given the importance of oil to the Malaysian economy.

Meanwhile, the local currency government bond yields trended lower between June 1 and August 15 for most markets in emerging East Asia due to dull global growth prospects, easing monetary policy regulations and investor flight to safe-haven assets.