Covid-19 looms over emerging East Asia LCY bond market
Credit spreads widen as investors take risk-averse approach
26 Jun 2020 | Chito Santiago

The uncertainty induced by the Covid-19 pandemic continues to drag on the emerging East Asia local currency (LCY) bond market as the investment sentiment globally and in the region diminish, even as the containment measures to limit the spread of the virus hinder economic activity.

The latest issue of the Asia Bond Monitor published by the Asian Development Bank (ADB) on June 25 notes that credit spreads have widened for nearly all markets in the region as investors took a risk-averse approach, with the share of foreign holdings in most of the emerging East Asia LCY bond markets also declining.

Risks to the global outlook remain heavily tilted to the downside, ADB says, mainly due to the uncertainty brought about by Covid-19, including the prospect of a longer period of minimal economic activity and further waves of infection outbreaks. Other risk factors include the US-China trade tensions, as well as the financial volatility due to capital outflows from emerging markets.

“Governments and central banks in the region have taken significant measures to mitigate the impact of Covid-19 through fiscal stimulus packages and easy monetary policies. But more needs to be done to strengthen the region’s economies and financial markets,” says ADB chief economist Yasuyuki Sawada. “While overall investment sentiment is still down, there are signs of recovery in some economies as quarantine measures are strategically relaxed.”

Government bond yields trended downwards in most regional markets between February 28 and May 29 this year, while the equity markets in emerging East Asia suffered losses and local currencies depreciated against the US dollar.

Overall, the amount of LCY bonds outstanding in emerging East Asia totalled US$16.3 trillion at the end of March, representing an increase of 4.2% from end-December 2019 and 14% from March 2019. Bond issuance in the region in the first quarter of 2020 amounted to US$1.7 trillion, up 19.7% from the fourth quarter of 2019. The outstanding LCY bonds in emerging East Asia as a share of gross domestic product (GDP) rose to 87.8% at the end of March from 83.3% at the end of December 2019.

Government bonds continued to account for the bigger share of the region’s LCY bond market at US$9.9 trillion (60.6%) at the end of March, while corporate bonds contributed the remaining US$6.4 trillion (39.4%). China remained the largest bond market in the region accounting for 76.6%, followed by South Korea with 12.5%. Bond markets in the Asean region accounted for an aggregate 9.1% share.

Meanwhile, foreign investor holdings of LCY government bonds were largely stable in the fourth quarter of 2019. The share of foreign holdings in China showed steady growth in each quarter of 2019 as foreign investors continued to be attracted to China’s bond market amid the gradual opening up of its capital market to foreigners.

In contrast, the share of foreign holdings in the Philippines LCY bond market peaked in December 2019 and has since been on a downward trend despite a series of policy rate cuts by the central bank last year. Foreign investors took profit and reduced their holdings on expectations that inflation would trend upward again.

In Malaysia, there was a spike in foreign holdings to 25.3% at the end of December 2019 from 23% at the end of September on the back of improved investor confidence as the government assured market participants that it would reach its budget deficit target of 3.4% of GDP for 2019, down from 3.7% in the previous year.

In Indonesia, the share of foreign holdings dropped marginally to 38.57% in the fourth quarter of 2019 from 38.64% at the end of September.