All global investors are keeping a close eye on Europe. They watch for risks. At the same time, they are also looking closely at the bond market development in Asia. But here they watch for opportunities.
Thirachai Phuvanatnaranubala.
Is this justified? Is it now the rise of Asian bonds?
The Need for Local CurrencyBond Markets
The markets for Asian bonds have come a long way since the 1997 Asian Crisis. It has been close to 15 years, but the picture of panic stricken people lining up outside financial institutions waiting to withdraw their savings is something difficult to erase from one's memory.
Nor is the sense of doom that was perpetuated in the local press, the rumours of financial collapse pending yet on another financial institution, the lack of tools to circulate money around that eventually spread beyond the financial system affecting trade credit and receivables, the hardship that fell hardest on the poor. I can never erase these out of my mind.
I realised there and then that it was important to speed up development of the bond market in the local currency. I saw that in a crisis, when the crunch finally came, men would easily distrust each other's credit. The same goes for banks.
I saw that before the crisis, the interbank market in Thailand was quite effective. Banks trusted each other well enough to lend to each other on an unsecured basis. But in the crisis, first the foreign banks stopped lending to the Thai banks. Then the large Thai banks stopped lending to the small Thai banks. Banks stopped lending to the finance companies.
The interbank market simply stopped. The same also occurred in the United States in the 2008 financial crisis, although it was not as damaging.
We therefore needed to speed up development of the bond market in local currency so that Thai financial institutions would have more high quality bonds in hand, bonds they could sell in times of crisis to look after themselves better; bonds they could still sell in the market even when other banks no longer trusted in their credit.
Over the past 15 years since the crisis, Asia has succeeded tremendously in developing their bond markets in local currencies. If we exclude Japan, the combined size of the Asian bond markets in 1997 was only US$176 billion, approximately 9% of GDP. Today, it has grown more than 30 times to about $5.5 trillion, approximately 53% of GDP.
In the case of Thailand, past development of the bond market has paid substantial dividends. The government has just issued an Emergency Decree allowing it to borrow for immediate investments in the system of rain water drainage up to the amount of 350 billion baht. This will take our public debt from 42% of GDP, to about 45%.
Despite this urgency, we expect the Thai bond market to have absolutely no difficulty in providing this amount of emergency funding.
What makes Asian bonds attractive?
The biggest attraction of Asian bonds is the fast economic growth underpinning Asian countries. Asian economies except Japan grew at a rate of 8.5% per year in 2010. This high rate is not the exception, but has persisted for many years. Such high growth rates enable Asian countries to more comfortably service their debts each year, far better than countries with stagnant growth.
Borrowings in Asia are mostly used to finance infrastructure that will enable the countries to achieve more sustainable growth and higher productivity in the future. The certainty of payback is therefore more assured than the borrowings on other continents that were used to finance state consumption or public welfare programmes.
But growth alone will not make Asian bonds attractive for long. In order to win the complete confidence of global investors, Asian bonds also need to have proper infrastructure.
The system of accounting and auditing must be sound. The level of transparency must be high. Governance must be well respected both at the government level and the corporate level. The ratings process must be reliable. The price discovery processes must be fair and efficient. There must be adequate market surveillance. Finally, the system for payment and settlement must be convenient and reliable _ in short, world class.
I believe many Asian bond markets have achieved high marks in these important aspects. The credit goes to the people involved, and in the case of Thailand, a lot of credit must go to the relevant government agencies as well as to the Thai Bond Market Association.
But is it enough just to have high economic growth and a good system? Is that enough to make Asian bonds attractive to global investors? My answer is no. We in Asia must set up a good system to prevent the distortion of risks as has occurred in Europe.
The Distortion of Risks in Europe
The root cause of the big bond market problem in Europe today goes back many years. It occurred because many risks were highly distorted. This distortion blinded people into taking on more risks than they had first planned for.
The distortion occurred after the euro was introduced. The credit risks of the sovereign bonds issued by countries in the European periphery were exactly the same before and after the introduction of the euro. But somehow many European investors wrongly viewed that they should have been upgraded.
Greece before the euro was paying a premium of 1.76% per annum more than Germany for a 10-year borrowing. Five years after the euro, the premium went down to 0.28%. For Portugal, the premium went from 0.37% down to 0.15%. For Spain, from 0.64% down to 0.16%.
Even with the premium having been squeezed, the peripheral countries were still judged to be very attractive investments. European banks therefore loaded up on these bonds. As of June 2011, European banks held as much as 434 billion euro worth of the peripheral bonds.
This is why the European debt crisis is so difficult to solve. If one writes down the sovereign bonds to real value, many European banks will incur sudden losses and will have to be immediately recapitalised. But they may find it difficult to raise new capital from the general public.
These banks may look to the European states to buy their shares. But for some peripheral countries it will be impossible, because of the problem of high sovereign debt in the first place.
We in Asia should therefore take these important lessons to heart in order to avoid these mistakes.
Thirachai Phuvanatnaranubala is the Finance Minister. The above address was delivered at the National Bond Market Conference in Bangkok on Jan 16, 2012.