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ASEAN-5 bond market development:Where does it stand? Where is it
going?
Joshua Felman, Simon Gray, Mangal Goswami, Andreas A. Jobst,
Mahmood Pradhan, Shanaka Peiris, and Dulani Seneviratne*
Since the late 1990s Asian crisis, ASEAN-5 countries have
expendedconsiderable effort in developing their bond markets.
However, the sizeof these markets relative to GDP has hardly
changed. Can we explain this?And does it mean that domestic markets
have not, in fact, developed? Thearticle argues that bond market
growth has been held back by a sharp fallin business investment,
which has left firms with little need for bondborrowing. Even so,
markets have developed in other ways, to such anextent that
substantial amounts of foreign portfolio investment havebegun to
flow into ASEAN-5 bonds. These developments have
importantramifications. With the investor base growing and
infrastructure invest-ment likely to rise, ASEAN-5 bond markets
could expand rapidly, holdingout the prospect that the region could
finally achieve twin engine finan-cial systems in the near
future.
Introduction
It has now been more than a decade sinceASEAN launched a major
effort to develop itsdomestic bond markets,1 which makes it agood
time to take stock, to see what has beenaccomplished, and what
remains to be done.This article attempts to do just that.
Althoughseveral authors have undertaken such an effort,there are
large differences in perspective
between this article and most other studies.First, most of the
other studies cast a muchwider net, focusing either on bond markets
inemerging Asia at large, or on the ASEAN+3.This study focuses
exclusively on theASEAN-5, which comprises Indonesia, Malay-sia,
Philippines, Singapore, and Thailand.Second, most other articles
come to relativelypessimistic conclusions. For instance, Mienoet
al. (2009) assert that the failure of corporatebond markets to
expand relative to GDP means
* Joshua Felman, Assistant Director, Research Department,
International Monetary Fund (IMF), Washington, DC,
USA,[email protected]; Simon Gray, Senior Financial Sector Expert,
Monetary and Capital Markets (MCM) Department, IMF,Washington, DC,
USA, [email protected]; Mangal Goswami, Deputy Director, IMFSingapore
Regional Training Institute,Singapore, [email protected]; Andreas A.
Jobst, Senior Economist, MCM Department, IMF, Washington, DC,
USA,[email protected]; Mahmood Pradhan, Deputy Director, European
Department, IMF, Washington, DC, USA, [email protected]; Shanaka J.
Peiris, IMF Resident Representative, Manila, Philippines,
[email protected]; Dulani Seneviratne,Research Officer, APD
Department, IMF, Washington, DC, USA, [email protected]. The
views expressed in thisarticle are those of the authors and should
not be attributed to the IMF, its Executive Board, its management,
or the currentemployers of the authors. Any errors and omissions
are the sole responsibility of the authors. An earlier version of
thisarticle was presented to an ASEAN-5 Deputy Governors seminar
held in Bangkok on November 5, 2010, and waspublished as IMF
Working Paper No. 11/137 (available at
http://www.imf.org/external/pubs/ft/wp/2011/wp11137.pdf), which
benefitted from discussion during that seminar and subsequent
comments from the ASEAN-5central banks. The authors wish to express
their gratitude for this helpful input.
1 ASEAN refers to the Association of Southeast Asian Nations.
ASEAN+3 includes P.R. China, Japan, and Korea.
doi: 10.1111/apel.12051
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2014 Crawford School of Public Policy,The Australian National
University and Wiley Publishing Asia Pty Ltd.
The International Monetary Fund retains copyright and all other
rights in the manuscript of this article as submitted for
publication.
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that the reforms have had little impact. Spiegel(2009) goes even
further, expressing doubtsabout some of the premises underlying
thereforms, including the argument propoundedby Greenspan (1999)
that capital markets canact as a spare tyre in case the banking
systembecomes impaired.
This article reaches very different conclu-sions. It argues that
ASEAN-5 bond marketshave undergone a quality transition, becom-ing
a more mature channel of funding, withlower barriers to entry. As a
result, two criticalchanges have taken place. Bond markets
haveindeed begun to serve as a spare tyre in caseother parts of the
financial system areimpaired; and they have begun to receivecopious
foreign inflows. These developmentshave important ramifications.
With the inves-tor base likely to expand as foreign investorsdevote
an increasing portion of their portfoliosto emerging market (EM)
assets, ASEAN-5bond markets could grow much more rapidlyover the
coming decade, to the point whereASEAN-5 could finally develop twin
enginefinancial systems. To seize this opportunity,however,
proactive policies will be necessaryto smooth the development path,
unlock exist-ing supply-side constraints, and minimise theattendant
risks such as market volatility.
The plan of the article is as follows. The nextsection recalls
why this initiative was so impor-tant to ASEAN, and outlines the
sweepingreforms that countries have introduced. SectionWhy have
corporate bond markets notexpanded? addresses the puzzle of
why,despite these efforts, ASEAN-5 bond marketshave not grown
relative to changes in GDP.Section A fundamental
transformationfocuses on other metrics of development,arguing that
these suggest that a remarkabletransformation of ASEAN bond markets
isindeed underway, especially if firm-level dataare examined in
greater detail. Section Theshape of things to come considers some
of theimplications of this transformation. The finalsection
concludes.
Why develop bond markets?
Across the globe, EMs have placed greatemphasis on developing
their bond marketsin recent years. Why have they done so? Inlarge
part, it is because EMs have heavyinvestment requirements and bond
marketsplay an important role in financing largeinvestment
projects. Such projects tend tobe risky and take time before they
yieldreturns; risks that bond markets can spreadover a large number
of holders of securities.Moreover, because bond contracts
(unlikeloans) are designed to be traded, they allowinvestors to
transfer credit risks to others,even before the projects are
completed. Thecombination of these characteristicsthescope for
risk-sharing and risk-shedding,both within and across national
boundariesmeans that bond markets complementbanks, which are
constrained by limits onthe scope of their cross-border
activitiesand the extent to which they can transformmaturities.
Beyond these general principles, there areparticular reasons why
ASEAN-5 countrieshave put so much emphasis on developingbond
markets since the Asian crisis. Thesereasons stem from the
consensus diagnosisof what happened in 1997. According to thisview,
the Asian crisis can be traced in largepart to several underlying
problems in nationalfinancial systems:2
Dependence on bank funding. Financialsystems were extremely bank
centric,which meant that most of the risks werebeing concentrated
in the bankingsystemand there was no alternatechannel of
intermediation.
Maturity and currency mismatches. Borrow-ing had suffered from a
double mismatch,since long-term, domestically orientedinvestment
projects were being fundedthrough short-term, foreign
currencyborrowing.
2 See, for example, Eichengreen (2006).
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Capital account vulnerabilities. Countries inthe region were
perceived to be excessivelydependent on volatile capital inflows;
asituation that struck many observers asironic because the region
had an abun-dance of domestic savings.
Observers argued that all three of theseproblems could be solved
by developingdomestic bond markets. Vibrant bond marketswould
create another funding channel, a sparetyre that firms could use in
case banksonce again encountered lending difficulties.Domestic
bonds would likely be issued overlonger term maturities and in
local currencies,which would eliminate the double mismatchproblem.
Finally, with greater domestic bondmarkets, firms could reduce
their dependenceon foreign capital markets.
Based on this diagnosis, ASEAN has putconsiderable effort into
developing its bondmarkets. For example, the ASEAN+3 createdthe
Asian Bond Market Initiative, which estab-lished working groups to
study the issues andmake recommendations, many of which havebeen
adopted by individual countries. TheAsian Development Bank also
initiated a studyprogram and created the Asia Bonds Onlinedatabase
so that researchers and market par-ticipants could easily find key
informationabout local currency markets.3 Meanwhile,the Executives
Meeting of East Asia PacificCentral Banks created pan-Asian bond
funds tofacilitate regional investment.
Despite these sweeping reforms, ASEAN-5bond markets have not
grown, measured asrelative to GDP (IMF 2010a). For most of thepast
decade the average stock of local currencybonds outstanding has
fluctuated around fiftyto fifty-five per cent of GDP.4 As a
result,ASEAN-5 has not been able to expand its sharein the EM bond
universe. A decade ago,ASEAN-5s domestic debt accounted for
aboutone-fifth of total EM domestic debt securities,excluding those
from China; today, the fractionis the same. If the rapidly
developing bond
market in China were to be included amongthe EM total, ASEAN-5s
share would havefallen, to about one tenth.
Why have ASEAN-5 bond markets notgrown? In part, it is because
the bulk ofASEAN-5 bondsaround thirty-five to forty40 per cent of
GDPare issued by govern-ments. Because budget deficits have
remainedlow for most of the past decade, there was littleneed for
them to issue additional debt. Buteven the size of the corporate
bond marketshas remained remarkably stable, hoveringuntil very
recently around just fifteen to eight-een per cent of GDP (Figure
1). This presents aprofound puzzle. Why have corporate debtmarkets
not expanded? And does that meanthey have not really developed? Let
us takethese questions in turn.
Why have corporate bond marketsnot expanded?
At the outset of ASEANs push to developbond markets, some
observers hoped that theregion could follow the same path as
LatinAmerica. In that region, bond markets hadbeen propelled
forward by the rapid develop-ment of contractual savings schemes,
such aspension funds. As these schemes expanded,their demand for
long-term domestic currencyassets increased, which in turn
encouragedfirms to respond by issuing more bonds.But this dynamic
failed to materialise in theASEAN-5. To understand why, consider
firstthe demand side of the market, that is to saythe investor
base. Has it failed to develop?
Primary market demand
In fact, the ASEAN-5 domestic investor basehas expanded
considerably over the pastdecade. But the expansion did not come
fromthe expected source. To the contrary, contrac-tual savings
schemes have shown remarkably
3 Nonetheless, data problems remain an issue. In some cases,
AsiaBondsOnline data differ widely from those available fromother
sources, such as the Bank for International Settlements (BIS).
Also, data for some variables is not available for allcountries,
hindering ASEAN-wide analysis.
4 For a discussion of what happened in 2009, see section A
fundamental transformation below.
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little growth. In Indonesia, Philippines, andThailand, the
assets of pension funds amoun-ted to less than 10 per cent of GDP
in 2000; andthey remain around that level today. Althoughpension
fund assets in Malaysia and Singaporeare relatively high by EM
standards, they havenot shown any trend growth either. Mean-while,
assets of life insurance companies havestagnated at low levels in
the Philippines andIndonesia, while rising by only a few
percent-age points in Malaysia and Thailand. As aresult, the share
of bonds held by contractualsavings institutions has diminished
consider-ably over time. In Malaysia, for example, nearlythree
quarters of government bonds were heldby social security
institutions in 2000. But tenyears later, their share has fallen to
less thanone third, while domestic financial institutionsnow
account for the bulk of the holdings.
What are these domestic financial institu-tions? Banks, of
course, in large part; butincreasingly, domestic mutual funds. A
decadeago, this sector was tiny, with total assets of lessthan US$5
billion, accounting for less than fiveper cent of GDP in all five
countries. But start-ing in the mid-2000s, they have explodedin
size in every country except Indonesia, tothe point where in
Thailand and Malaysiatheir assets now amount to more than US$50
billionaround twenty and thirty per cent ofGDP, respectively.
Largely as a result, domesticfinancial institutions now hold two
fifths ofMalaysian government bonds, double theshare they held in
2000. But this only deepensthe mystery. If the investor base has
expanded,why did firms not meet this increase indemand by providing
more supply?
Primary market supply
The main reason firms failed to issue morebonds relates to the
profound change in themacroeconomic environment after the
Asiancrisis. During the early 1990s, investmentreached 40 per cent
of GDP in some ASEAN-5countries, as firms raced to expand their
opera-tions in booming markets. To fund theirexpansion projects
(and the associated capitalformation), firms relied increasingly on
exter-nal finance, boosting their leverage ratios toexceptionally
high levels. After the Asian crisis,however, this process shifted
into reverse.Firms became much more cautious, reducingeconomy-wide
investment rates to aroundtwenty-five per cent of GDP for much of
thepast decade before increasing them againduring the boom of the
past few years.
Figure 1ASEAN-5: corporate bond markets and investment
10
15
20
25
0
5
2000
Q4
2002
Q4
2004
Q4
2006
Q4
2007
Q2
2007
Q4
2008
Q2
2008
Q4
2009
Q2
2009
Q4
2010
Q2
2010
Q4
2011
Q2
2011
Q4
2012
Q2
2012
Q4
25
30
35
15
20
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
ASEAN-5: Local currency corporate bonds outstanding(In percent
of GDP)
ASEAN-5: Gross capital formation(In percent of GDP; PPPGDP
weighted average)
Sources: AsianBondsOnline and Asian Development Bank (2013) and
IMF staff calculations (ASEAN-5: local currency corporate
bondsoutstanding); and IMF (2013b) (World Economic Outlook) and IMF
staff calculations. (ASEAN5: gross capital formation).PPP =
purchasing power parity.
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The International Monetary Fund (IMF)sAsia-Pacific Regional
Economic Outlook (IMF2010a) explored the roots of this fall in
invest-ment. It found that the main causes were lowerreturns,
greater uncertainty, and altered percep-tions of the ease of doing
business. During thedecade following the Asian crisis, growth
inAsia was slower and much more volatile thanearlier, reducing
firms incentive to expandcapacity. At the same time, investors
becamemore cautious in extending funds to businesses,as perceptions
of the business climate deterio-rated in the wake of the problems
that the crisisrevealed. In other words, causation has goneboth
ways: the decline in investment hasreduced the demand for finance,
while financialconstraints have also discouraged investment.
At the same time, firms found alternativeways to fund their
investment projects. As partof the post-Asian crisis changes, firms
strove toincrease their profitability and succeeded indoing so.
Consequently, they were able to funda much larger portion of their
diminishedinvestment needs from internal cash genera-tion. The
crisis also led to a shift in the type ofinvestment, away from
construction, which istypically financed by borrowing; and
towardsmanufacturing for export, which is financed in amuch wider
variety of ways. In particular,ASEAN manufacturing companies tend
tofinance themselves through equity, includingdirect equity
investments. Teranishi et al. (2007)found that companies from
Thailand, Malaysia,and Indonesia rely for their long-term
fundingmuch more heavily on equity finance, and, strik-ingly, much
less on banks than do corporationsin advanced countries. According
to Mieno(2009), firm capital represented 53 per cent ofthe average
balance sheet for listed Malaysiancorporations, while bank
borrowing accountedfor only 14 per cent; the figures for Thai
corpo-rations were similar. Unsurprisingly, then,aggregate figures
for the ASEAN-5 show thatequities account for nearly two thirds of
corpo-rate domestic financing, with bank credit andbonds splitting
the remainder.5
Summing up, the expansion of the domesticinvestor base created
an opening for ASEAN-5corporate bond markets. But firms failed
toseize this opportunity because they had littleneed to issue over
the past decade. Does thisfailure to expand means that markets have
notdeveloped? Not at all. Development has manydimensions and, on
many of these metrics, pro-gress is clear. In fact, ASEAN-5 markets
havebeen fundamentally transformed.
A fundamental transformation
To track this transformation, we undertake afirm-level analysis,
which reveals that in awell-defined sense, it has become easier
forfirms to access ASEAN-5 corporate bondmarkets. Then, we consider
two of the moredramatic manifestations of the
transformation.Specifically, the corporate bond market hasdeveloped
into a spare tyre that corporates canuse when other parts of the
financial systemcome under stress; while foreign investorshave
become eager to purchase domesticbonds.
Firm-level analysis
There are many ways to assess the quality of abond market. But
perhaps the most importantmetric is its usefulness to potential
borrowersin terms of accessibility and price competition.For
example, a bond market may be irrelevantto most firms because it is
highly concentrated,dominated by a handful of large firms or
largeissues. Or its usefulness could be limitedbecause firms
issuances need to be very high,accounting for a large proportion of
theirbalance sheets, in order to overcome barriers toentry (in the
form of high transaction costs).
Measured in this way, bond market devel-opment can be conceived
as following a certainpattern. Initially, when the market is at a
veryearly stage, only a few firms will be largeenough or
financially well-regarded enough
5 A further important structural factor is the large role
played, within the manufacturing sector, by
foreign-investedcompanies. In a series of studies, Mieno and others
(Mieno 2008; Mieno et al. 2009) have argued that since the
mid-1980s,when ASEAN became an increasingly important base for
multinational manufacturing production, foreign corporationshave
become an increasingly important funding channel for local
companies.
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(with a long track record and audited publicaccounts) to issue.
Moreover, because there aresizeable fixed costs to issuing bonds
andbecause firms want to establish liquid bench-mark issues, the
size of these initial issues isnormally large relative to firm
balance sheets.But over time, as markets mature and econo-mies
develop, concentration ratios and the rela-tive significance of
issuance tend to decline.
Markets will no longer be dominated by afew large issuers, or a
few large bond issues,because more and more firms are able to
issue(quantity transition, Figure 2 above). Thatsaid, the extent to
which new firms enter themarket is inhibited by the cost of
monitoringborrowers. Clearly, banks are better placed toengage in
information-intense monitoringof many (relatively small) borrowers,
whichwould be quite costly for typical public marketinvestors.
As bond markets mature, the economic sig-nificance of individual
bond issues will alsotend to decline, partly because as
issuancebecomes routine, firms issue smaller amountsfrequently
rather than occasional large
amounts; and because these minimum amountswill become small
relative to the size of growingbalance sheets (quality transition).
Conversely,however, large issuers might be inclined to con-solidate
different issues to concentrate andenhance liquidity in some
limited and impor-tant benchmarks, which could limit the extentto
which the relative importance of issuancesdeclines in maturing bond
markets as a result ofincreasing economies of scale.
Initially, without considering strategicissuer behaviour and
other factors, the marketstarts off in the second quadrant, with
highconcentrations and high significance. Butgradually, as the
market develops, it movesinto the third quadrant, with low
concentrationand low significance.
So much for theory. What is the evidence forthe ASEAN-5? Some
key indicators are pro-vided in Table 1 below, based on local
currencyissuance by the nonfinancial private sector.Because the
sample sizes for Philippines,Singapore, and Indonesia are very
small,it is perhaps best to focus on Malaysia andThailand.6 In
these two markets, one can seesome clear progress: the amount of
issuancehas been increasing steadily; the number ofissues and
issuers has increased sharply; andwith the influx of new issues,
the averagematurity has shortened.
At the same time, progress in reducingconcentration and
significance (of individualissues) has been mixed. On the positive
side,concentrationwhether measured by issuance(for example, a few
large bonds) or by issuers(for example, a few large
companies)inMalaysia, and to a lesser extent in Thailand, isnow
down to the levels of Brazil and Korea.But concentration in other
ASEAN-5 countriesremains high. Similarly, the significance of
newissues (issuance relative to balance sheet size)has diminished
in Malaysia to the levels of themost advanced EMs, but remains high
in othercountries.
6 Bond issuance and balance sheet information (total assets))
data were obtained for five ASEAN countries as well as twoemerging
market comparator countries (Brazil and Korea). Bond issuance data
include all local currency-denominated,non-financial, private
sector transactions during each sample year (2000, 2005, 2009, and
the first two quarters of 2010).Note that issues by financial
companies and special purpose vehicles (SPVs) were excluded; in the
latter case becausethese entities are levered financing vehicles,
rather than operating companies. As a result, the sample size for
Singaporeis too small to be reliable.
Figure 2Bond market development
Co
nce
ntr
atio
n o
f is
suer
s:R
elat
ive
shar
e of
issu
er s
ize
Balance sheet significance:Issuance relative to individual total
assets
21
43
High concentrationof issuers
and high significance of
bond issuance
Low concentrationof issuers
andlow significance of bond issuance
Quality transition:Debt optimization
Quantity transition:More and smaller
issuers
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Over the past decade, ASEAN-5 countriesand EMs in generalhave
developed, in thesense of moving towards the third quadrant(low
concentrationlow significance). Aftercontrolling for concentration,
Philippines andMalaysia tend to have higher levels of
signifi-cance. That is to say, the average issuancevolume relative
to issuer balance sheets ishigher in countries with less developed
bondmarkets, as the theory would predict. Cur-rently, the state of
development in Malaysiaand Thailand is not all that far from Korea
andBrazilat least as measured by these dimen-sions. The
concentration has declined despitecontinued issuance by larger
issuers that domi-nated the primary market during the nascent
stages of development. Even so, none of theASEAN-5 countries has
firmly entered thethird quadrant. So, more progress needs to bemade
in diversifying the issuer base and ensur-ing that issuance becomes
a more routinemethod of financing operations.
The conclusions of the firm-level analysiscan be summed up
simply. Firms access tobond markets has improved considerably
inrecent years. A decade ago, only the largest andbest-known firms
were able to issue bonds, sotheir issues dominated local markets.
Gradu-ally, however, more and more firms have beenable to issue,
creating broader markets thanbefore. This qualitative progress has
culmi-nated in two critical developments.
Table 1ASEAN-5 and selected emerging market countries:
characteristics of local currency corporate bond
issuance (20002010)
Local currency (LCY) non-financial corporate bond issuance:
sample analysis
Issuance (in USD billions) Issuance/total assets ratio (median,
in percent)
IDN MYS PHL THA SGP BRA KOR IDN MYS PHL THA SGP BRA KOR
2000 . . 0.9 . . . . 1.2 . . 18.8 . . 36.7 . . . . 10.4 . .
3.92005 0.7 4.3 1.1 2.6 . . 1.2 20.5 6.7 11.0 18.2 6.3 . . 2.5
5.62009 1.5 5.7 2.2 8.1 0.1 12.6 47.8 3.5 5.6 4.9 9.0 7.6 5.4
5.82010 1.1 2.4 1.0 3.0 0.2 11.8 19.5 3.1 5.3 9.0 8.6 17.6 8.0
4.9
Average maturity (in years) Number of issues/issuers
IDN MYS PHL THA SGP BRA KOR IDN MYS PHL THA SGP BRA KOR
2000 . . 13.5 . . . . 4.5 . . 3.0 . . 54/6 . . . . 19/12 . .
970/1892005 6.0 9.2 5.8 9.2 . . 7.4 2.5 6/6 198/38 6/6 16/6 . .
13/11 1160/2062009 3.9 6.6 5.2 4.6 4.6 5.0 2.4 45/20 158/50 23/11
83/36 14/5 73/52 2068/5042010 5.6 2.1 6.0 4.3 5.7 5.1 2.6 23/9
175/70 4/3 71/30 8/5 87/49 670/188
Concentration of issuance volume 1/ Concentration of issuer
assets 1/
IDN MYS PHL THA SGP BRA KOR IDN MYS PHL THA SGP BRA KOR
2000 . . 0.08 . . . . 0.10 . . 0.04 . . 0.01 . . . . 0.99 . .
0.042005 0.59 0.04 0.43 0.19 . . 0.11 0.02 0.26 0.03 0.16 0.14 . .
0.05 0.052009 0.12 0.06 0.11 0.06 0.51 0.03 0.02 0.12 0.07 0.03
0.03 0.52 0.03 0.022010 0.08 0.04 0.26 0.10 0.15 0.03 0.04 0.12
0.09 0.16 0.13 0.03 0.07 0.03
Data excludes issuance by state-owned enterprises, all financial
institutions and international organizations. 2010 information
includes Q1 andQ2 available data. 1/ logarithmic and re-scaled,
standardized HerfindahlHirschman index (HHI): issuance
concentration = log [min (HHIi,HHIi min (HHIN)] (0,1), where HHIi =
[(share of issuance amount by issuer i in a given year)2 1/total
number N of issuers i] / (1 1/totalnumber N of issuers i). The
closer the value to zero, the less concentrated the annual issuance
of corporate bonds; 1/ logarithmic and re-scaled,standardized HHI:
issuer concentration = [min(HHIi,HHIi-min(HHIN) / (max (HHIN)-min
(HHIN))] (0,1), where HHIi = [(balance sheet assetsof issuer i
relative to total balance sheet assets of all issuers in a given
year)2- 1/total number N of issuers i] / (1-1/total number N of
issuers i).The closer the value to zero, the less concentrated the
issuer size.Sources: Bloomberg, Worldscope, Moodys KMV as well as
national stock exchanges.BRA = Brazil, IDN = Indonesia, KO = Korea,
MYS = Malaysia, PHL = Philippines, SGP = Singapore, THA =
Thailand.
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The new spare tyre
Amid the depths of the global financial crisisbetween 2007 and
2009, there was a suddensurge in domestic bond issuance by
emergingAsian corporates. For years, the stock ofemerging Asian
corporate bonds outstandinghad been stagnating as a percentage of
GDP.But in the second quarter of 2009, the stockincreased by nearly
ten per cent quarter-on-quarter in the ASEAN-5 and more than 20
percent quarter-on-quarter in emerging Asiaexcluding China. In the
third quarter, there wasa further large increase. By the end of the
year,ASEAN-5 local currency corporate bond issu-ance had reached a
US$58 billion, higherthan the previous peak, reached in 2007,
androughly double the normal level.
This surge was striking for a number ofreasons. To begin with,
as noted in sectionWhy have corporate bond markets notexpanded?,
ASEAN-5 corporates typically donot rely much on bond issuance for
funding.Moreover, the surge took place in the middle ofa severe
recession, when private sector invest-ment had fallen sharply. So,
firms had littleneed to issue bonds in order to finance invest-ment
projectsthey were not initiating newones and they were slowing down
the ones
that were already underway. Nor were firmsforced to issue bonds
just to sustain them-selves; corporate profitability actually held
upreasonably well during the recession.
So, what explains the issuance boom? Theprimary factor appears
to have been a reac-tion to changes in bank behaviour.
Normally,bank-centred financial systems maintain theirlending ties
to their clients, even duringdifficult timesbut this was not a
normaldownturn. Even though liquidity in the Asianbanking systems
was ample and capitaladequacy was never in doubt, Asian
banksnonetheless followed their Western peers andbecame more
cautious after Lehmans bank-ruptcy. They tightened their lending
standardsand reduced their prime lending rates muchmore slowly and
partially than the declinein policy and bond interest rates. Both
mea-sures encouraged firms to turn to the capitalmarkets, while
reducing their use of bankcredit (Figure 3). In fact, adding the
twosources of funding together, total credit to thecorporate sector
declined in the first half of2009 in the ASEAN-5 countries. So, the
bondissuance was not additionalcorporates weresubstituting one form
of financing for another.In other words, the domestic bond
marketacted precisely as reformers had originally
Figure 3ASEAN-5 countries: local currency corporate bond
issuance and corporate lending
(20072012)
5
10
15
20
10
5
0
2007Q4
2008Q2
2008Q4
2009Q2
2009Q4
2010Q2
2010Q4
2011Q2
2011Q4
2012Q2
2012Q4
ASEAN-5Emerging Asia, excluding China
7
8
5
6
3
4
1
2
0
1
12008Q2
2008Q4
2009Q2
2009Q4
2010Q2
2010Q4
2011Q2
2011Q4
2012Q2
2012Q4
Local currency corporate bonds(Quarterly percent change in
amount outstanding)
ASEAN-5: Bank credit to corporates(Q/Q percent change, local
currency, average)
Sources: Bank for International Settlements (2013) and IMF staff
estimates (for Local currency corporate bonds); and CEIC Data
Co.Ltd (2013); Haver Analytics (2013); and IMF staff estimates (for
ASEAN-5: bank credit to corporates).
FELMAN ET AL. ASEAN-5 BOND MARKET DEVELOPMENT
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2014 Crawford School of Public Policy,The Australian National
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-
hoped it would; it became the spare tyre thatcorporations could
use if the bank-financingchannel were to be impaired.
Where was the demand for these bondscoming from? Much of the
demand appears tohave come from overseas, as global risk appe-tite
began to revive with the stabilisation ofadvanced country financial
systems and asprospects in EMs appeared better than in theWest. As
a result, inflows into EM debt fundsresumed in May 2009, and
quickly reachedlevels approaching the peak of the 200507global
boom. In short, ASEAN-5s domesticbond markets were able to become a
spare tyreduring the Great Recessionone of the keyoriginal
objectivesbecause of another accom-plishment. Foreigners were now
willing topurchase domestic currency bonds, reducingthe risk that
corporates would be forced toendure a currency mismatch in order to
securebond financing. This development raises twocritical
questions. Were the foreign purchasesduring the global crisis
merely a temporaryphenomenon, or did they truly reflect adurable
shift in foreign investor behaviour? Ifforeign investor behaviour
has changed funda-mentally, how did this happen?
The rise of foreign investment
After the Asian crisis, Eichengreen andHausmann (1999) argued
that EM economieswere beset by an original sin. According tothis
theory, EMs would inevitably suffer fromthe double mismatch
problem. Foreign inves-tors were wary of issuers from such
countriesand unwilling to purchase local currencybonds. The only
way to convince them toprovide the needed finance was to issue
globalbonds, denominated in foreign currency,bearing relatively
short maturities, and subjectto the legal jurisdiction of an
international
financial centre. This model was based on theLatin American
experience, and it was neverentirely clear how well it applied to
ASEAN-5.After all, ASEAN-5 did not have a history ofhyperinflation,
exchange rate instability, ordefaults, which had deterred
investments inLatin America. Still, it remained true thatforeign
investment in ASEAN-5 bonds wasminimal. Even as recently as the
middle of2004, foreigners accounted for less than 2 percent of
holdings of ASEAN-5 governmentbonds.7 But this situation changed
markedlyafter the global financial crisis. Starting in 2010(and
continuing through mid-2013), bondinflows surged; during some
periods, evenoutpacing equity flows, which had
historicallydominated portfolio inflows. To a certainextent, this
was merely a cyclical phenomenon,a reaction to the extraordinary
divergencebetween the bright prospects in EMs and thedifficult
situation in advanced countries,including the extraordinarily loose
monetarypolicy that the latter were forced to adopt. Butmore
long-lasting structural factors have alsobeen at work. Foreign
holdings of EM localcurrency bonds have been increasing for
sometime, starting well before the global crisis. By2007, foreign
holdings had passed 8 per cent;by 2008, they had reached 10 per
cent; and aftera brief dip during the global crisis, they surged,to
around twenty-seven per cent by 2012(Figure 4).
As foreign purchases of domestic bondshave increased, issuance
of foreign currencybonds has receded. The high-water mark offoreign
currency corporate bonds came in2002, when the amount outstanding
reached 6per cent of ASEAN-5 GDP, implying that morethan one third
of total corporate bonds weredenominated in foreign currency. But
in subse-quent years, the share of foreign bonds gradu-ally fell;
so much so that by the first quarter of2010, it amounted to one
fifth of the total.8 (That
7 Based on available data from Indonesia, Malaysia, and
Thailand. These numbers may understate foreign interest,
asforeigners were also gaining exposure to local markets through
access products. See section Dealing with offshoreactivity.
8 For comparison, according to the BIS, at end-2008, the
outstanding stock of emerging market bonds issued in
majorinternational markets (that is, international bonds) amounted
to about US$1 trillion, while bonds issued in domesticmarkets
amounted to US$6 trillion.
ASIAN-PACIFIC ECONOMIC LITERATURE
68
2014 Crawford School of Public Policy,The Australian National
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-
said, it should be noted that foreign currencycorporate
issuance, like that of domestic cur-rency issuance, surged after
2009.)
Two factors explain these developments.One is the development of
corporate bondmarkets themselves. As they have expanded(in nominal
terms, even if not relative toGDP), and become more accessible,
they haveattracted liquidity-conscious foreign investors.In
addition, macroeconomic fundamentalshave improved. Hausmann and
Panizza (2003)found that the degree of original sin was posi-tively
related to the level of development(proxied by GDP per capita), the
strength ofmacroeconomic fundamentals (inflation andgovernment
debt), exchange rate flexibility,and the size of the investor
base.9 Strikingly,ASEAN-5 countries have made considerableprogress
along every one of these dimensionsin recent years. In particular,
economic funda-mentals have improved to the point where insome ways
they are now much stronger than inadvanced nations, whose fiscal
positions havedeteriorated in the wake of the financial crisis.The
average ASEAN-5 government debt to
GDP ratio is less than half the advancedcountry average, which
is expected by the IMFto reach 112 per cent of GDP in 2013
(IMF2013a).
This performance has not gone unnoticed. Adecade ago, dedicated
EM debt funds werealmost invisibly small. By 2005, they
werereceiving annual inflows of around US$5 billionper year. By
2010, inflows reached US$35billion. Even allowing for the large
cyclicalelement in recent flows, the underlying upwardtrend has
been persistent. What will it imply forthe future of ASEAN-5s bond
markets?
The shape of things to come
The ramifications of growing foreign participa-tion are
difficult to predict. Precisely becausethere has been little
foreign investment indomestic markets until recently, there is
verylittle empirical evidence on the benefits andcosts of foreign
participation in bond marketdevelopment (Daniel 2008).
9 Burger and Warnock (2007) have a different list. They find
that countries with higher scores on capital mobility,
marketliquidity and efficiency, regulatory quality and creditor
rights, market infrastructure, taxation on bonds, and the size
ofthe local institutional investor base, tend to attract great
cross-border participation.
Figure 4Foreign investor participation in government bond
markets
0
5
10
15
20
25
30
35
40
Mar
-98
Dec
-98
Sep
-99
Jun-
00M
ar-0
1D
ec-0
1S
ep-0
2Ju
n-03
Mar
-04
Dec
-04
Sep
-05
Jun-
06M
ar-0
7D
ec-0
7S
ep-0
8Ju
n-09
Mar
-10
Dec
-10
Sep
-11
Jun-
12M
ar-1
3
Total IndonesiaMalaysia Thailand
05
10
152025
303540
45
Mar
-98
Sep
-98
Mar
-99
Sep
-99
Mar
-00
Sep
-00
Mar
-01
Sep
-01
Mar
-02
Sep
-02
Mar
-03
Sep
-03
Mar
-04
Sep
-04
Mar
-05
Sep
-05
Mar
-06
Sep
-06
Mar
-07
Sep
-07
Mar
-08
Sep
-08
Mar
-09
Sep
-09
Mar
-10
Sep
-10
Mar
-11
Sep
-11
Mar
-12
Sep
-12
Brazil South AfricaHungary MexicoPoland Turkey
ASEAN-5: Foreign holdings of local currency governmentbonds 1/
(In percent of total outstanding)
Emerging markets: Foreign holdings of local currencygovernment
bonds (In percent of total outstanding)
Sources: AsianBondsOnline and Asian Development Bank (2013) (for
ASEAN-5: foreign holdings of local currency government bonds);and
Country authorities (2012); IMF Global Financial Stability Report
(2013); and IMF staff estimates (for Emerging markets:
foreignholdings of local currency government bonds); 1/ includes
Indonesia, Malaysia, and Thailand.
FELMAN ET AL. ASEAN-5 BOND MARKET DEVELOPMENT
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2014 Crawford School of Public Policy,The Australian National
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Developmental benefits
Some potential benefits seem clear. To beginwith, overseas firms
could expand the investorbase, compensating for the slow growth in
tra-ditional domestic investors such as the contrac-tual savings
schemes. Indeed, the potentialimpact could be quite large. A survey
by theIMF (2010b) indicates that global bond fundsremain
underweight EMs, providing scope fora continued stock adjustment
into dedicatedEM funds. Because global bond and hedgefunds are very
large relative to local bondmarkets, even a marginal increase in
theweight of EMs in their portfolio could lead to asignificant rise
in demand.10
Over time, the shift in demand is likely tobecome significant.
In fact, it is possible thatincreasing investment in EMs is now at
thebeginning of a secular trend, benefitting fromgreater foreign
demand, especially given theneed of advanced country pension
systems toimprove their returns. In the USA, the PewCenter on the
States (2010) estimated in 2010that there was a US$1 trillion gap
between theUS$3.4 trillion in pension, health care, andother
retirement benefits that States havepromised their workers and the
US$2.4 trillionthat they have set aside to pay for them. Theneed to
close this gap will put growingpressure on pension fundswhich
currentlyinvest little in EM debtto increase
theirallocationsespecially because the yields onsuch debt exceed
the US rates by a widemargin.
Intraregional flows are compounding flowsreceived from outside
Asia. Some regionalcentral banks have started buying their
neigh-bours financial assets in a bid to diversifyreserve holdings,
achieve a better risk-returnprofile, and contain sterilisation
costs. Individ-ual investors have also been investing in Asianbonds
through local mutual funds. Thai inves-
tors, for example, in recent years, have beenlarge accumulators
of Korean bonds.
Additional foreign demand could helpreduce bond yields (IMF
2005). To estimatehow large this effect could be, Peiris
(2010)employs a panel data framework to estimatethe impact of
foreign participation in determin-ing long-term, local-currency,
governmentbond yields in a group of ten EMs between2000 and 2009.11
His analysis suggests thatgreater foreign inflows do reduce
governmentyields, after controlling for other domestic andexternal
factors including global interest ratesand risk aversion. The
effect is reasonablylarge, with a 10 percentage point increase in
theshare of bonds held by foreign investors gen-erating a decline
in yields of about 60 basispoints (Figure 5).
Greater foreign participation will alsoimprove liquidity. The
larger the number ofparticipants, the greater the diversity of
prefer-ences and views; which leads to more trading,better price
discovery, and more efficientmarkets. Foreign participants are
particularlybeneficial for liquidity because they are muchmore
likely to trade domestic securities thandomestic institutional
investors, who typicallyfollow buy-and-hold strategies. Case
studiesconducted by the World Bank and IMF (2001)on government bond
markets in emerging andmature markets confirm this effect
qualita-tively. The relationship between greater
foreignparticipation and liquidity appears to hold alsoin the
ASEAN-5 region.
Finally, greater foreign participation willcreate a virtuous
circle that will expand the sizeof the debt markets themselves. As
interestrates fall and liquidity improves, more firmswill find it
attractive to issue. As more firmsissue and market size grows, more
inves-tors will be enticed to participate. This willreinforce the
utility of the market as a sparetyre. Because bond maturities are
typically of
10 For example, IMF (2010b) estimates that a one percentage
point reallocation of global equity and debt securities held byG-4
real money investors, which amounts to about US$50 trillion, would
result in additional portfolio flows of US$485billion, larger than
the record annual portfolio flows to EMs of US$424 billion recorded
in 2007. Assuming that half ofthese inflows are allocated to debt
(as has been the case recently) and that the debt flows are
allocated proportionately tothe outstanding volume of bonds
(excluding China), the ASEAN-5 countries could receive an
additional US$50 billion ininvestments per year.
11 The ten EMs are Brazil, Czech Republic, Hungary, Indonesia,
Mexico, Malaysia, Korea, Thailand, Turkey, and Poland.These
countries were selected because they had significant foreign
participation in their domestic markets.
ASIAN-PACIFIC ECONOMIC LITERATURE
70
2014 Crawford School of Public Policy,The Australian National
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longer duration than bank loans, the moreASEAN-5 corporates
shift to bond finance, thebetter their underlying liquidity
situation willbe, as they will have secured financing forlonger
periods. It will also give corporates aspare tyregreater
liquiditythat it can use asinsurance, even before crises takes
place.
Potential costs
What are the potential costs to bond markets ofthis increased
foreign participation? To beginwith, inflows into the bond market
can compli-cate the conduct of monetary policy. Some ofthe problems
are well known, as they apply toany type of capital inflows,
including theequity and bank inflows with which ASEAN-5countries
are long familiar. But some of thecomplications are new.
In particular, if inflows are channeled intodomestic government
bonds, long-term rateswill be affected. It is difficult to say, a
priori,whether this helps or hinders central bankoperations. To the
extent that bond marketsbecome more liquid and attuned to
centralbank signals regarding future interest rates (asopposed to
being dominated by institutionalinvestors that need to buy
long-term assets tomatch their liabilities) transmission mecha-
nisms could be improved. However, to theextent that yield curves
become dominated bydevelopments elsewhere in the world, mon-etary
independence will be reduced. Indeed,during 2010 ASEAN-5 countries
were con-fronted with the same Greenspan dilemmathe USA faced in
the mid-2000s. Even as somecountries raised their short-term rates,
foreignpurchases were causing long-term rates to fall.
Another potential risk is greater interest ratevolatility.
Surges in foreign inflows are oftenfollowed by sudden withdrawals,
as ASEANdiscovered in 1997, after the collapse of LehmanBrothers in
September 2008, and after the USFederal Reserve announced in May
2013 thatthey would be winding down their large-scaleasset
purchases (quantitative easing).
Still, even if foreign participation and yieldvolatility are
related in the short run, the rela-tionship may be much weakeror
even non-existentover the longer term. That is because,as Prasad
and Rajan (2008) have noted, foreignparticipation can be a
stabilising force for localmarkets. Foreign investors frequently
exertpressure for more transparency, which reducesprice volatility
because it improves the qualityand increases the frequency of
information.Such changes reduce the risk that there will besudden
disclosures of accumulated negative
Figure 5Impact of foreign participation in bond markets
0
20
40
60
80
100
120
140
160
180
30
20
10
0
10
20
30
40
50
2003
Q1
2003
Q3
2004
Q1
2004
Q3
2005
Q1
2005
Q3
2006
Q1
2006
Q3
2007
Q1
2007
Q3
2008
Q1
2008
Q3
2009
Q1
2009
Q3
2010
Q1
2010
Q3
2011
Q1
2011
Q3
2012
Q1
2012
Q3
In p
er c
ent
In U
S d
olla
r bi
llion
s
Total capital inflows (left
scale)IndonesiaMalaysiaPhilippinesSingaporeThailand
Brazil
South Africa
Hungary
Indonesia
Korea
Mexico
Poland
Thailand
y = -1.57x + 19.106R = 0.0676
0
5
10
15
20
25
30
35
0 1 2 3 4 5 6
Ave
rage
fore
ign
part
icip
atio
n (2
005
2012
)
ASEAN-5: Capital inflows and debt market returnvolatility
Emerging markets: Foreign participation and yieldvolatility
Volatility of government bond yield (20052012)
Malaysia
Turkey
Sources: IMF [International Financial Statistics database (BPM6)
IMF 2013c], Bloomberg LP (2013), EMBIG Index, and CEMBI index(for
ASEAN-5: capital inflows and debt market return volatility); and
IMF staff estimates in standard deviations (for Emerging
markets:foreign participation and yield volatility).
FELMAN ET AL. ASEAN-5 BOND MARKET DEVELOPMENT
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2014 Crawford School of Public Policy,The Australian National
University and Wiley Publishing Asia Pty Ltd.
-
news. Moreover, in cases where they do occur,foreign
participation attenuates the priceimpact, because it broadens what
would other-wise have been a thinner market. The cross-sectional
analysis of ten EMs with significantforeign participation in the
local currency gov-ernment bond market found no clear correla-tion
between foreign participation and bondprice volatility over
200009.12
Finally, there are some concerns that rever-sals of bond flows
are more destabilising thanequity outflows because the stronger
domesticre-pricing of equities endogenously moderatesoutflow
pressures. Yet the empirical evidencethat bond flows are more
volatile than equitiesis weak.
Is there a way to secure the longer-term ben-efits of greater
foreign participation, whilereducing the potential short-term
volatilitycosts? Again, because the demise of originalsin is so
recent, there is little internationalexperience that can be drawn
upon for lessons.One potentially significant measure was takenby
Indonesia in July 2010. At that time, foreigninvestment had been
pouring into bank secu-rities [called Sertifikat Bank Indonesia
(SBI)], inpart because of carry-trade activity by hedgefunds in
which investors borrow in currenciessuch as the US dollar where
interest rates arelow in order to invest in currencies, such as
therupiah, where interest rates are high. To reducethe attendant
risks, Indonesia imposed a one-month holding period on SBIs,
applicable todomestic and foreign holders. In principle,
thismeasure should circumscribe the scope forforeign outflows when
global risk aversionrises, because investors will no longer be
ableto exit their SBI positions quickly. Precisely forthat reason,
it should also discourage short-term carry trade inflows in the
first place.13
The question is how effective the measurewill prove in practice.
So far, there is no clear
evidence that it has affected aggregate foreignholdings of
Indonesian securities, which ini-tially fell, then reached new
heights, beforefalling again. Nor is it clear how well themeasure
will succeed in limiting outflows,because investors wishing to exit
theirpositions could hedge them by selling otherIndonesia
assets.
There may also be some unanticipated sideeffects. For example,
the associated decision toeliminate the three-month SBI appears to
haveimpeded the development of the nascent inter-est rate swap
market by eliminating its bench-mark rate. (Central bank term
deposits exist,but may not be an adequate substitute becausethey
are not traded.) Consequently, it may takesome time before the
measure can be properlyassessed.
Dealing with offshore activity
The rise of foreign interest in domestic bondshas another
important ramification: growingoffshore activity. Foreign investors
are increas-ingly obtaining exposure to EMs by usingvarious access
products, such as over-the-counter (OTC) derivatives, structured
secu-rities, or offshore special purpose vehicles.Modes of access
include innovative financialinstruments such as nondeliverable
forwardsand other derivative instruments, includingcredit-linked
notes. Partly as a result of theseactivities, derivatives
transactions with under-lying EM assets have exploded in recent
years.
Aside from the obvious benefit of ensuringthat counterparty risk
is focused on a fewfamiliar developed market financial
institu-tions, investors stay offshore mainly becauseof impediments
or costs to entering. Some ofthese impediments are:14
Limits on access to money market or othershort-term
instruments;
12 Similarly, Peiris (2010) shows that foreign presence does not
necessarily result in greater volatility in local governmentbond
markets, in part because domestic markets seem to then import low
levels of volatility during the (much longer)periods of
tranquillity in international markets.
13 Holding restrictions could also discourage investments by
ordinary long-only, open-ended, mutual funds because
dailyredemptions require the ability to sell securities.
14 The nature and extent of impediments differ widely from
country to country. For example, Malaysia has none of
theimpediments listed below. In fact, Malaysia has made its bond
market internationally accessible via international
centralsecurities depositories (Euroclear and Clearstream) to
enable foreign investors to settle securities transactions without
theopening of a local custodian account.
ASIAN-PACIFIC ECONOMIC LITERATURE
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2014 Crawford School of Public Policy,The Australian National
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-
Clearing and settlement protocols andcustody arrangements, such
as custodycontrols, directed settlement, and rules onsub-custody;15
and
Minimum holding periods.Does any of this matters? It does, for
severalreasons. Controls and taxes that drive activityoffshore
thereby reduce liquidity onshore andimpair price discovery. In
other words, theyreduce efficiency. They also reduce transpar-ency.
For example, with much of the activitytaking place beyond their
jurisdiction, in rela-tively opaque OTC markets, national
author-ities will find it difficult to monitor marketdevelopments.
Indeed, a significant proportionof bonds owned by the domestic
financialsector may actually be held on behalf of foreigninvestors
(typically by onshore banks) throughderivative structures.
A shift towards offshore activity may alsoraise prudential
concerns. Offshore marketsmay be less well regulated and, in any
case,will not be regulated by home country author-ities. Moreover,
even though controls mightexist that aim to isolate domestic
markets fromthose offshore, inevitably firms find ways toarbitrage
between the two. As a result, devel-opments in markets offshore can
be transmit-ted onshore. In that case, compensating policyaction
might prove difficult because nationalauthorities may not have much
information onthe genesis or the nature of the underlyingshock.
For all these reasons, over time it may bebeneficial to try to
bring such markets onshore.One way to do this is by reducing or
eliminat-ing withholding taxes. However, such ameasure would raise
difficult issues of equityand efficiency. For example, if
non-residentsare exempted from withholding tax, this couldlead to
practices such as coupon washing,where bonds are sold during the
couponpayment periodperhaps via repo and/orsecurities lendingto
investors paying low orzero withholding tax. Alternatively,
residentinvestors may begin to route purchasesthrough offshore
routes to avoid or reduce thecost of withholding tax. On the other
hand, if
withholding tax on bonds is abolished for resi-dents and
non-residents, this might create adistortion favouring bond markets
over equitymarkets.
Conclusion
In the decade leading up to the global financialcrisis,
exceptional efforts to expand ASEAN-5sbond markets were undercut by
broader mac-roeconomic trends. Firms had little need toissue, since
they were reducing their invest-ment ratios. Meanwhile, on the
demand side,foreigners remained reluctant to purchase localcurrency
bonds.
Since 2009, however, these two trends havereversed, perhaps
decisively. Unlike mostother regions, ASEAN-5s growth
acceleratedafter the crisis, underpinned by the regionsstrong
fundamentals, low wages, and highcommodity prices. Investment rates
havestarted to rise again, spurring firms to issuedebt. Meanwhile,
foreigners have becomeincreasingly willing, even enthusiastic,
aboutbuying domestic bonds. These developmentshold out the prospect
that ASEAN-5 bondmarkets could enter into a virtuous circle inwhich
greater demand reduces interest ratesand increases liquidity,
encouraging firms toissue, thereby expanding the market size
andattracting more investors.
However, these new trends will bring newpolicy challenges in
their wake. Measures willbe needed to deepen local capital
marketsfurther so that financial systems can act as abetter shock
absorber against capital flow vola-tility, thereby limiting its
impact on the realeconomy. Also, it may be worthwhile trying
tobring markets onshore by removing barriersto entry, including
withholding taxes.
In sum, ASEAN-5s strenuous efforts of thepast decade have
already succeeded in trans-forming its bond markets. But the
develop-ments of the past decade may well be dwarfedby changes that
may take place in the yearsahead. Time will tell.
15 The cost of appointing a local custodian can make
cross-border investments unattractive.
FELMAN ET AL. ASEAN-5 BOND MARKET DEVELOPMENT
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-
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