Nov. 22 (Bloomberg) -- Asia's government bond market grew faster than the value of corporate debt issued in the Chinese yuan, Malaysian ringgit and other local currencies for the first time in 18 months, according to the Asian Development Bank.

The market for government bonds denominated in local currencies expanded by 10 percent in the first half of the year, driven by new issuance by China, Thailand, Malaysia and Indonesia and other Asian governments to absorb excess liquidity, according to the Asia Bond Monitor released today.

Governments in the region are issuing more bonds to curb rising asset prices and to slow currency appreciation caused by an influx of capital. Still, extended volatility in global financial markets and diminishing appetite for risk sparked by concern that losses tied to defaulted U.S. subprime mortgages will deepen ``could lead to a reversal of capital flows'' to Asia, according to the report.

``Record high capital flows, especially to financial markets, have increased pressure on currencies to appreciate, enhanced already abundant liquidity in the region,'' the Asian Development Bank said in the report. ``Surging capital inflows, however, impose a significant challenge to the region as inflationary pressures build and world interest rates continue to rise.''

Asia's economic growth and ``robust'' financial sector has cushioned the blow from the collapse of the subprime-mortgage bond market, caused by rising defaults in the U.S. by home buyers with poor credit histories, according to the report.

Spillover Risks

``Although the region is more resilient than in previous periods of financial market turbulence, generally deteriorating global economic growth and credit conditions, prolonged volatility, a sharper-than-expected slowdown in U.S. growth, and a resurgence of inflationary pressures could spill over into local currency bond markets,'' the Asian Development Bank said.

The Manila-based lender forecast in September that Asian economies excluding Japan and Australia will expand by 8.3 percent this year and 8.2 percent in 2008.

The value of local-currency bond markets in Asia increased to $3 trillion in the first half of this year, a 9.9 percent increase from the $2.7 billion trillion of bonds outstanding at the end of 2006, and 17.2 percent more than in June 2006, according to Asia Bond Monitor.

China's Half

China's government local currency bond market expanded by 15 percent in the six months ended June 2007, in line with the average annual growth rate of 31 percent, the Asian Development Bank said in the report. China now accounts for 52 percent of the total government debt market in Asia, the multilateral lender said.

Government bonds sold in Malaysia's local currency, the ringgit, grew by 23 percent in value in the first half of this year, while Indonesia's market expanded by 8 percent and Thailand's 12 percent. Vietnam's market gained 43 percent in value, the most in the region due to its need for infrastructure development, according to the report.

Local currency corporate bond markets expanded at a slower pace in the six months to June 30 after beating growth in the government bond market in the previous 18 months due to rising cost of short-term funding, the Asian Development Bank said. The Philippines and Vietnamese corporate bond markets grew the most, according to the report.

Philippine companies issued 175.7 percent more bonds in the local currency to replace maturing dollar-denominated debt, compared with a 50 percent increase in the second half of last year, according to the report.

Vietnam's Largest Issuers

Vietnam's market for corporate bonds expanded by 56 percent, half the 112 percent achieved in the previous six months, as some of the largest issuers chose to sell dollar bonds, the report shows. Corporate bonds accounted for 9.4 percent of the total value of dong-denominated debt as of June 30, up from 2.5 percent at the end of 2005, according to the report.

In Indonesia, a cut in the central bank's reference rate from 9.75 percent to 8.25 percent in July also encouraged companies to tap demand for rupiah-denominated bonds. That market grew by 25 percent in the first half of the year from 2 percent in the second half of last year, the report said.

Governments in Asia also made regulatory changes to help expand their bond markets, according to the report. China, for example, removed requirements for corporate issuers to obtain a bank guarantee for bond issues and allowed mainland companies to issue yuan bonds in Hong Kong.

``It is good that the markets in Asia are more developed,'' said Phoon Chiong Tuck, Singapore-based chief investment officer for the region at Deutsche Asset Management. ``Asia needs a lot financing especially for infrastructure and for economic development.''

To contact the reporter for this story: Denise Kee in Singapore at Dkee2@bloomberg.net

Last Updated: November 22, 2007 01:02 EST