26/09/2013

Iwan J. Azis Head Office of Regional Economic Integration Asian Development Bank

Key Messages
Post-GFC & Post-QE: New World of finance; massive amount and volatile capital flows, especially bank-led & debt-led flows Emerging East Asias LCY bond market continued to expand, albeit at a moderate pace reaching US$6.8 trillion at end-June 2013. Expectations of QE tapering by Federal Reserve has resulted in capital outflows leading to rising bond yields and depreciating currencies, and falling FCY bond issuance (June and July) especially in the high yield market Tapering postponement gives a breathing space

26/09/2013

Key Messages
When there is a large gap between bonds outstanding and holdings, standard policy such as interest rate changes can have large effects on corporate balance sheets Lack of investment in infrastructure in the region can hamper future growth prospects having missed the opportunity to ramp up infrastructure spending when liquidity was plentiful. Developing regional bond markets can help the region bridge the financing gap for infrastructure (pension fund, insurance, market infrastructure)

QE Policy to Stabilize US Financial Market: Effective in Lowering US Long-Term Yield Rates

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Oct-12 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Apr-13 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12

QE 1 11/2008

QE 2
Feds Assets (in US$ trillion) Q1/2011

QE 3 12/2012

Securities Held Outright

All Liquidity Facilities*

Support for Specific Institutions**

Other Assets

Total Assets

QE1: Nov 2008-Mar 2009 large-scale asset purchase program, extended to Mar 2010. Feds securities holdings surged to $2 trillion in 2010. QE2: end of 2011q2 purchase of $600 billion of longer-term Treasury securities QE3: new $40 billion/month, open-ended, bond purchase program of agency MBS; Dec 2012 increased to $85 billion/month in Dec 2012. By January 2013, Feds total assets reached unprecedented $3 trillion Sep 18: The Fed refrained from reducing $85 bill/month needs more4 evidence of lasting improvement; rising rates threaten expansion.

26/09/2013

Phase 1

Phase 2

FOMC Statement: July 31, 2013

the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longerrun goal, and longer-term inflation expectations continue to be well anchored.

FOMC Statement: Sept 18, 2013

Conditions in the job market today are still far from what all of us would like to seeThe committee has concern that rapid tightening of financial conditions in recent months would have 6 the effect of slowing growth.

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3 Phases of Global Liquidity: How It is Manifested in Emerging Asia

Phase 1: The period leading up to the GFC and the immediate aftermath of the Lehman Brothers bankruptcy in September 2008 bank-led flows; expanded balance sheets of banks resulted from increasing non-core liabilities that facilitated loans and risk-taking behavior. Phase 2: Began in 2010 as a by-product of QE capital inflows surged into emerging Asian markets searching for yield; rising share of LCY bond holding incl. foreign ownership; issuance of international securities by governments and corporates increased Phase 3: Post May 2013 following QE tapering announcement capital outflows; bond yields and prices; policy dilemma intensifies

Emerging East Asias LCY Bond Market Continues to Grow

US$ billion 8,000 7,000 6,000 5,000 4,000 3,000 2,000

Phase 1

Phase 2

Phase 3

1,000
0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 June 2013

Government

Corporate

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LCY-Bond Size

LCY-Bond Issuance

26/09/2013

10-Year Government Bond YieldsUnited States (%) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13
Note: Data up to 13 Sep 2013. Source: Bloomberg.

May 13: QE Tapering

Rising yields and depreciating currencies after Fed tapering comments

2-Year Government Bond (bps) 10-Year Government Bond (bps) 87 104 (16) 57 70 127 133 290 60 67 70 100 41 104 (25) 99 56 61 188 28 5-Year Credit Default Swap Spread (bps) 0 (7) (1) (0.3) 11 9 150 110 4 47 35 0 6 42 0 18 6 247 23 Equity Index (%) 1.7 (3.7) (6.9) (0.4) (2.0) (1.3) (1.4) (16.3) 0.5 (0.6) (16.1) (9.6) (2.1) (14.3) (5.3) (7.7) 4.1 (0.1) 0.6 5.5 FX Rate (%) (5.0) 3.5 (3.4) 0.2 0.1 (14.5) (16.2) 2.6 (8.5) (6.4) (0.1) 0.3 (6.0) (0.5) (3.4) (3.4) (3.4) (3.4) (3.4) Major Advanced Economies United States 20 United Kingdom 15 Japan (1) Germany 23 Emerging Asia China, People's Rep. of 90 Hong Kong, China 21 India 169 Indonesia 315 Korea, Rep. of 19 Malaysia 29 Philippines 49 Singapore (3) Taipei,China 16 Thailand 26 Viet Nam 100 Select European Markets Greece 2 Ireland 40 Italy 65 Portugal 219 Spain 18 = not available, bps = basis points, FX = foreign exchange. Notes: 1. Data reflect changes between 22 May 2013 and 12 September 2013.

2. For Emerging Asia, a positive (negative) value for the FX rate indicates the appreciation (depreciation) of the local currrency against the US dollar. 3. For European markets, a postive (negative) value for the FX rate indicates the depreciation (appeciation) of the local currrency against the US dollar. Source: Bloomberg LP, Institute of International Finance (IIF), and Thomson Reuters.

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Foreign holdings of LCY government bonds down slightly

% 40 35 31.85 30 25 30.34

20
17.90 15

10
5 0

9.47 8.41

Dec-04

Sep-05

Dec-05

Sep-06

Dec-06

Sep-07

Dec-07

Sep-08

Dec-08

Sep-09

Dec-09

Sep-10

Dec-10

Sep-11

Dec-11

Sep-12

Dec-12

Mar-08

Mar-05

Mar-06

Mar-07

Mar-09

Mar-10

Mar-11

Mar-12

Jun-12

Jun-05

Jun-06

Jun-07

Jun-08

Jun-09

Jun-10

Jun-11

Mar-13

Japan

Indonesia

Malaysia

Thailand

Republic of Korea

FCY bond issuance slumped

US$ billion 25

G3 Currency Bond Issuance

20

15

10

0 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13

Note: G3 bond issuance is defined as gross bond issuance denominated in G3 currenciesUS dollar, euro, and Japanese yen. Source: Asia Bond Monitor.

Jun-13

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Indonesia: Bond Prices (Total Return) Reinforced By Interest Rate Hike

August 10, 1982=100

15

Companies face losses when interest rates rise as bond holdings exceed bonds outstanding
China, People's Republic of
CNY billion 25,000 20,000

Indonesia
IDR billion 900,000
800,000 700,000 600,000 500,000

15,000
10,000 5,000 0

400,000 300,000 200,000 100,000

Sep-11

Sep-12

Dec-10

Dec-11

Dec-12

Jun-11

Jun-12

Mar-11

Mar-12

Mar-13

Jun-13

Sep-09

Sep-10

Sep-11

Sep-12 Sep-12 Dec-12

Dec-09

Dec-10

Dec-11

Corporate Holdings of LCY Bonds

LCY Corporate Bonds Outstanding

Corporate Holdings of LCY Bonds

LCY Corporate Bonds Outstanding

KRW billion 1,600,000 1,400,000

Korea, Republic of

MYR billion 700 600 500 400 300 200 100

Malaysia

1,200,000
1,000,000 800,000 600,000 400,000 200,000 0

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Jun-07

Jun-08

Jun-09

Jun-10

Jun-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Jun-12

Mar-13

Dec-07

Dec-08

Dec-09

Dec-10

Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Dec-11

Jun-07

Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Dec-12 Mar-13 Jun-13

Jun-09

Jun-10

Jun-11

Mar-10

Mar-11

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12 Mar-12

Corporate Holdings of LCY Bonds

LCY Corporate Bonds Outstanding

Corporate Holdings of LCY Bonds

LCY Corporate Bonds Outstanding

Jun-12

26/09/2013

Infrastructure Financing Requirements for Asia are large

Sector/Subsector Energy (Electricity) Telecommunications Mobile Phones Landlines Transport Airports Ports Railways Roads Water and Sanitation Sanitation Water Total New Capacity 3,176,437 325,353 181,763 143,590 1,761,666 6,533 50,275 2,692 1,702,166 155,493 107,925 47,568 5,418,949 Replacement 912,202 730,304 509,151 221,153 704,457 4,728 25,416 35,947 638,366 225,797 119,573 106,224 2,572,760 Total 4,088,639 1,055,657 690,914 364,743 2,466,123 11,261 75,691 38,639 2,340,532 381,290 227,498 153,792 7,991,709

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But banks have been cutting back on lending

US$ billion 16

Sources of Infrastructure Project Finacing Flows to Asia

14

12

10

0 2005 2006 2007 2008 Year 2009 2010 2011 2012

European Union

Japan

China, People's Rep. of

Australia

North America

Other Asia

Note: Other Asia includes Bangladesh, Brunei Darussalam, India, Indonesia, Malaysia, Pakistan, the Philippines, the Republic of Korea, Singapore, Thailand, and Viet Nam. Source: Infrastructure Journal Online.

Pension funds could help bridge financing gap

Amount of Sovereign Pension Fund Assets (US$ million)
Country China, People's Rep. ofa Hong Kong, China Indonesia Malaysia Philippines b,c Singapore Korea, Rep. of Thailand 2005 8,102 110 4,000 69,659 4,452 74,906 160,319 6,986 2012 49,026 212 14,399 183,761 7,443 186,243 326,209 18,253

Notes: a Latest data as of end-2010. b Earliest data as of end-2006. c Latest data as of end-2011. Source: OECD Pension Funds Data and Sovereign Pension Funds Annual Reports.

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26/09/2013

Indonesia

India

Concluding remarks
Bond markets in the region were benefited by capital flows (Phase 1 & 2), subsequently affected by QE tapering announcement (Phase 3), although more resilient than in 1997/98 need to accelerate improvements As bond market developed, bond holdings exceeds issuance, rising interest rates could result in mark-to-market losses. In retrospect, the region missed the opportunity to ramp up spending during period of plentiful liquidity. Banks have been reducing their project financing but pension funds can help bridge the financing gap. Looking ahead: Given (1) post-May turmoil experience; (2) banks inability to provide l.t financing; (3) huge requirement for infrastructure; it is expected that the actual tapering will not alter the growing trend of bond market

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