Few bright spots

IFR SSA Special Report 2022
10 min read
Paolo Danese

Asian capital markets have taken a beating from global inflation, lockdown measures in China and the war in Ukraine, which continue to hamper bond issuance from the region's SSAs. By Paolo Danese.

There is no hiding from the increasing likelihood of a global recession, and that means even typically regular issuers such as SSAs have had to revise their borrowing plans. The challenges are manifold, from inflation trends to the Ukraine war and its threat to global energy supplies.

The US Federal Reserve has responded to rising inflation by hiking rates, with the latest move on May 4 seeing a half-point increase, bringing the federal funds rate to the 0.75%–1% range, with several more rises expected.

The other key global player, China, has meanwhile responded in symmetrically opposite fashion, more worried about its slowing economy than inflation, as the country struggles with the cost of enforcing a “zero-Covid” cases policy that has seen even key hubs of Shanghai and Beijing buckle under the weight of the lockdown restrictions.

The People’s Bank of China has stayed in easing mode, with more interest rate and reserve requirement ratio cuts well in the cards for the rest of the year.

“The PBoC’s monetary support has so far disappointed market expectations,” Adrian Zuercher, head of asset allocation for APAC at UBS, wrote in an April report.

“But we need to bear in mind that 1Q real GDP beat expectations, growing 4.8% year-on-year. So the urgency to issue policy support will likely increase once April and May macro numbers come out.”

Such dramatic shifts leave Asia-Pacific SSA issuers between a rock and a hard place. The period between 30 November 30 2021 and March 9 2022 saw bond yields in emerging East Asia rise given the inflationary pressure and spillovers from the dramatic adjustments in the developed economies, Asian Development Bank noted in a March report.

And, while the risk-off phase kicked off by the start of the Ukraine war during the last week of February has passed, markets have cooled substantially.

Maria Lomotan, assistant treasurer of the Asian Development Bank, said that ADB’s funding programme is expected to be in the range of US$34bn–$36bn this year, with over US$18bn already raised so far. The key, Lomotan noted, was flexibility amidst the upheaval in the markets.

“Impact of Russia’s invasion of Ukraine has been felt acutely in Central Asia, due to these economies' close economic and financial links with Russia,” she said.

“Bond markets and funding rates have been roiled by steep rises in central bank policy rates and government yield curves. ADB has maintained a nimble approach in accessing issuance windows to implement its programme. Investors have continued to be supportive of ADB’s funding programme across markets.”

The challenges continue as overall international bond issuance from ASEAN countries amounted to US$107bn in 2021, close to the record level of US$109bn in 2020. Issuance of G3 currency bonds in emerging East Asia was US$376.4bn in 2021, a 0.5% year-on-year fall from the US$378.1bn in 2020, according to ADB data.

In aggregate, Asian sovereign issuers accounted for about 20% of primary international issuance last year, the International Capital Market Association noted in a March report.

As of the end of April 2022, there had been 23 public deals in the Asian SSA market, for a total issuance of US$10.3bn, Bloomberg data showed.

Staying local but sustainable

While international bond issuance struggles, Asian SSAs are relying on local currency markets, which grew as a market to a total outstanding of US$22.8trn as of the end of 2021, to meet their funding needs. Of that total, bond issuance amounting to US$14.3trn was from government issuers, a reliance that helps them mitigate the risks from currency and maturity mismatches, as well as reduced reliance on cross-border financing, ADB noted. The share of foreign currency debt in emerging Asia has, as a result, declined since 2000.

ADB’s Lomotan said the organisation continued to make efforts to diversify its funding programme across markets and has issued in 13 currencies and over 50 transactions so far this year. In Asian local currency markets, ADB was preparing to tap the Georgian lari and Kazakhstani tenge, among others.

Another chunk of Asian SSA bonds that will likely be heading for investors’ portfolios in increasing quantities are, in addition to the already popular green bonds, sustainability bonds, which are instruments tied to the United Nations’ Sustainable Development Goals agenda.

“We see sovereigns coming to the market with sustainability bonds more regularly,” said Mushtaq Kapasi, chief representative, Asia-Pacific, ICMA.

“This is tied in with sovereigns who have their own commitment to the Paris agreement, so this type of issuance becomes natural for them. They are promoting sustainability policies as a sovereign, policies that they can encapsulate in the sustainability bond frameworks.”

Kapasi said that the issuers benefit from these bonds both in terms of their contribution to achieving SDG goals as well as for their ability to diversify an SSA’s investor base, given the increasing number of funds investing exclusively in green and sustainable instruments.

Another benefit is in the occasional, though not guaranteed, pricing advantage for sustainable bonds, which have, especially in tight markets, occasionally issued tighter than their regular bond counterparts.

Notable sustainable deals from the region have included Indonesia’s own bond, the first SDG-linked deal from Southeast Asia. The €500m deal, priced in August 2021, is part of what is meant to be an annual roadmap of green and sustainable deals by the country. The 12-year bond priced with a coupon rate of 1.3%.

Another deal in the category was Thailand’s August 2020 sustainability bond. The 15-year inaugural deal in the category was followed up by two more tranches in the following months, which brought the total sustainable fundraising exercise to Bt50bn (US$1.44bn). The deal was also eventually listed overseas on the Luxembourg Green Exchange in April 2021.

Issuance in the category has also been boosted by the persisting effects of the Covid-19 pandemic.

“It is very clear that many of the measures or investments for some of the problems coming with the pandemic are in line with social bonds’ use of proceeds,” said Kapasi. “If you are funding hospitals and vaccinations, these can be justified investments for social bonds.”

Despite the continued focus on SDGs, some suspect geopolitics may well throw a wrench in those plans, too.

“We have seen SDG/ESG investment principles being challenged when Russia invaded Ukraine on February 24,” wrote Warut Promboon, head of research, at fixed income research outfit Bondcritic, in a March 31 report.

“Many international companies have pulled out of Russia and we could start to see more differing ESG standards between the West and Russia/China in years to come. Collaboration between the West and Russia/China on ESG principles could be a challenge as well.”

Central banks in driver's seat

Ultimately, the outlook for most SSA issuers will depend on the combination of macro conditions and monetary policy choices. That holds particularly true for countries more dependent on energy imports and the related risks from increasing oil prices as the Russia-Ukraine conflict drags on.

“Many APAC sovereigns have relatively strong external buffers, but tighter global financing conditions and higher oil prices would exacerbate external funding risks for low-rated frontier market sovereigns,” Fitch wrote in an April 5 report.

“APAC sovereigns have mostly maintained relatively low inflation and interest rates, but faster US monetary tightening in the adverse scenario and increased domestic inflationary pressures would likely reduce the scope for accommodative monetary policy settings.”

That could end up forcing countries to further delay stabilising and reducing debt from elevated post-pandemic levels, although North Asia sovereigns, including Greater China, may have more tolerance than those in the rest of the region.

The most recent adjustments have included Fitch has changed Japan’s outlook to stable on March 25, affirming its Single A rating, while downgrading Sri Lanka to C on April 14.

On the positive side, while inflationary pressures are building in Asia, inflation remains generally more subdued than in most other parts of the world.

“Many central banks are lagging their global peers in the tightening cycle, and we generally expect them to hike policy rates by less,” Thomas Rookmaaker, head of Asia-Pacific sovereigns, and Maxime Darmet, economist, both at Fitch Ratings, told IFR.

“There are some exceptions, though, such as India, Mongolia, and Pakistan. The Bank of Korea is also ahead of most of its regional peers, having already raised policy rates by 100bp since last year, but we think it is nearing the peak level in this cycle. The Bank of Japan will likely keep its monetary settings very loose, though it could opt to raise its cap on the 10-year yield a bit.”

As for Southeast Asia, underlying inflationary pressures remain moderate, mitigating the outlook. Fitch added that they expect Bank Indonesia to proceed with a moderate 75bp cumulative policy rate hike this year.

“Pressure on sovereigns could, in particular, continue to build in the frontier markets that are already facing refinancing challenges, such as Sri Lanka and Pakistan,” said Rookmaaker.

To see the digital version of this report, please click here

To purchase printed copies or a PDF of this report, please email gloria.balbastro@lseg.com