- India also increasing quota for foreign buyers of its debt
- Reallocation could push up bond costs from Korea to Indonesia
China and India opening their bond markets threatens to lure funds from the rest of Asia, pushing up regional borrowing costs.
The yuan’s likely ascent to the IMF’s reserves basket will lure $1 trillion of foreign money to Chinese debt in the coming years, Goldman Sachs Group Inc. said. Overseas investors hold around 1 percent of the $3.6 trillion of Chinese local-currency government notes, compared with 40 percent in Indonesia, 32 percent in Malaysia and 17 percent in Thailand. India, with outstanding sovereign paper equivalent to $639 billion, announced in September a plan to lift the cap on foreign ownership to 5 percent by early 2018 from 3.8 percent.
A drop in demand would be an additional headwind for Asian nations that have already seen borrowing costs soar on the prospect of higher U.S. interest rates, slower global economic growth and plunging commodity prices. Ten-year bond yields have risen by more than 3 percentage points in Indonesia over the last three years and by almost 90 basis points in Malaysia, compared with declines in China and India.
“There is a risk of lower liquidity as foreign investors choose to express their
views on Asian bonds via China and India,” said Manu George, Asian fixed-income director at Schroder Investment Management (Singapore Ltd.), whose bond team oversees $10 billion. “So the liquidity premium is likely to rise” and smaller markets with lower yields including Taiwan, Hong Kong and the Philippines will probably be most affected, he said.
IMF Managing Director Christine Lagarde said late Friday that her staff have recommended that the yuan become one of the lender’s reserve currencies along with the dollar, euro, yen and pound. The decision, which requires board approval on Nov. 30, sets the stage for more foreign investment.
Greater availability of Chinese sovereign debt may affect countries with similar credit ratings and yield levels the most. China is rated Aa3 at Moody’s Investors Service, the fourth-highest investment grade, the same credit assessment as South Korea and Taiwan. Thailand and the Philippines, although rated lower, also have yields that are comparable to China’s, where 10-year notes pay a return of 3.16 percent.
Foreign holdings of Indian local debt could definitely reach 10 percent over the next few years and this will pose a threat to similarly-rated Indonesia, said Nicholas Spiro, managing director at Spiro Sovereign Strategy in London. The two countries are rated Baa3 by Moody’s and their 10-year bonds yield 7.66 percent and 8.65 percent, respectively.
Indonesia doesn’t see China and India damping demand for its debt as “liquidity in the global market is quite ample,” said Robert Pakpahan, director-general of the Finance Ministry’s budget financing and risk management office in Jakarta.
China’s pool of outstanding sovereign debt dwarfs its regional counterparts. It’s about five times as large as South Korea’s $772 billion market, according to Asian Development Bank figures. The Thai, Indonesian and Malaysian markets combined amount to $484 billion.
While the trajectory of U.S. interest rates, commodity prices and the extent to which China slows will continue to be the main drivers of bond yields in the region, the opening up of the two biggest developing economies will be an additional factor that could push up borrowing costs, according to Spiro.
“These are huge markets with massive potential for foreigners to increase their exposure,” he said. “If there is more foreign money being plowed into these markets, then inevitably that’s going to change the landscape.”
China and India’s bond markets are likely to open to overseas funds at a gradual pace and “any crowding-out of foreign flows from Southeast Asia is likely to be limited,” said Joel Kim, the Singapore-based head of Asia-Pacific fixed income at BlackRock Inc., which oversees $4.5 trillion. That view was echoed by his counterpart at Aberdeen Asset Management Plc, Adam McCabe, who said he doesn’t expect to see a “marked impact” on borrowing costs in the rest of Asia.
ADB sees a sixfold increase in the amount of Chinese sovereign notes held by foreigners over the next five years, said Thiam Hee Ng, a senior economist at the Manila-based lender. While there may be some reallocation within Asia, it will probably be marginal and China is more likely to attract money from developed markets, he said.
“A lot of the funds don’t invest in the smaller Asian economies because their bond markets are too small,” Thiam said. China is “severely underweighted” in global assets so there will be a flood of new money as “you are adding a much more attractive asset into the pool,” said Thiam.
At least initially, there may be some substitution effect as more sovereign issuance chases a limited pool of funds and Indonesia, Malaysia and the Philippines could bear the brunt of that, said Vishnu Varathan, a Singapore-based economist at Mizuho Bank Ltd.
“Borrowing costs could be driven higher by competitive forces,” he said. “There will be more scrutiny on the nuances of credit ratings and the risk-adjusted ratings as the market deepens, led by the largest economies in Asia.”