Making Asia's bond markets work for the region

Emerging East Asia's local currency bond market has snowballed in the last decade to more than $4 trillion, but there has not been a parallel increase in trading activities in most countries.

This is a hurdle Asia needs to cross because only competitive and active bond markets can create an accurate yardsticks for governments, companies and other borrowers to gauge just how much they should be paying for the funds they raise. Without these benchmarks, chances are that they will pay too much for the money they need for crucial infrastructure or to expand their business, for example.

Central banks and monetary authorities can also make their monetary policy felt more quickly and effectively if local money and bond markets are liquid. Such moves will help maintain the fine balance always necessary to keep economies on an even keel but particularly important now when Asia is facing a strong revival in growth and perhaps inflation.

What's more, policymakers across Asia agree that governments, local companies and the people need to start directing their vast savings toward local markets, where the funds can be channeled into long-term investments, rather than lock them away in lower-yielding foreign markets. Investors will only start to do this if they see that it's just as easy to get in and out of homegrown markets as it is in the developed US, European or Japanese bonds markets.

Given all that, it's critical that policymakers do all they can to make their domestic bond markets - and the region's markets - more liquid.

Most local government bonds enjoy moderate activity - as measured by trading volumes - largely because most investors see them as safe haven assets. But most corporate bonds hardly ever trade after they have been in the market for a few months, with the notable exception of China, which has lately seen hefty issuance coupled with determined measures to boost investor buying of bonds sold by local companies.

And trading is more or less concentrated in bonds with short-term maturity periods - less than three years, perhaps. In most countries, it's hard to transact bonds that mature in more than 10 years. This means it's hard for borrowers to obtain funds for long-term projects or for investors to find long-term homes for their savings. In this respect, Indonesia is a welcome exception by dint of efforts in recent years to encourage longer-dated issuance to avoid a repeat of the 1997-98 maturity mismatches.

A just-released annual liquidity survey, conducted by ADB's AsianBondsOnline website, has found that liquidity in local debt markets improved this year compared with 2008 when the collapse of global financial markets caused the US dollar - and then other - debt markets to seize up. Nevertheless, the markets are still significantly less active than those of the developed economies.

The key way to bridge that gap is to bring a wider range of investors into Asia's markets because different investors have different opinions on and motivations for the market, and employ varying trading strategies. A broader investor base not only boosts trading volumes but can also dampen volatility at times of market stress since not all investors will opt to either enter or leave a market at the same time.

Here in Asia, that means governments need to look at policies to spur the interest of domestic social security, pension and investment funds and corporate treasuries on top of the banks and financial institutions that currently dominate the local markets.

Authorities in many countries are already taking steps to attract a wider variety of investors to their local bond markets and encouraging local and foreign firms to raise funds in Asian currencies.

China, for one, has given insurers the go-ahead to invest in instruments backed by infrastructure projects and raised their corporate bond investment limits. Another example is Singapore, which recently allowed retail investors to participate in auctions of government bonds and treasury bill auctions through the automated teller machines of major banks. More such measures are needed around the region.

Cooperation in developing a regional bond market and making rules easier for cross-border issuance of Asian currency bond is another way to promote investor diversity. The Asian Bond Market Initiative of the ASEAN+3 grouping has been working on measures to raise issuance of domestic bonds and attract institutional investors by creating a robust policy and regulatory structure.

Drawing a broad range of investors to the market takes time. It needs the right combination of policies, regulations and market infrastructure to entice a heterogeneous class of investors to allocate more funds to local currency bond markets.

Tax rates, development of hedging instruments, currency regulations and adequate settlement systems are all issues that every government in the region has to and continue to assess as its economies and markets are maturing. Difficult as such reforms seem, the hard work is both critical and necessary as the region's economies and markets head into the post-crisis world.

The author is chief economist and head of Asian Development Bank's Office of Regional Economic Integration.

(China Daily 12/02/2009 page9)