The emerging East Asia’s local currency ( LCY ) bond market grew in the third quarter of 2021 amid the rising global inflation and a shift in the US monetary stance that weakened regional financial conditions. 

According to the latest issue of Asia Bond Monitor published by the Asian Development Bank ( ADB ) on November 26, the LCY bond volume in the region rose 3.4% to US$2.17 trillion in January-September this year despite the increase in bond yields, weakening currencies and higher risk premiums in the wake of higher inflation and the US Federal Reserve announcing it would limit bond purchases starting in November.

The quarter-on-quarter increase in the third quarter represented a faster growth rate from the 2.9% rise recorded in the three months to June due to higher issuances from both the government and corporate bond segments. Most governments in the region continued to issue sovereign debt to finance their economic relief measures amid the Delta variant-driven resurgence of Covid-19 cases. Growth in the corporate debt, on the other hand, was underpinned by robust issuances as companies locked in low interest rates, and most central banks in the region maintained accommodative monetary policies to support economic recovery.

ADB’s acting chief economist Joseph Zveglich, Jr notes that the encouraging macroeconomic outlook and accommodative policy stances are supporting the region’s financial conditions. However, central banks in emerging East Asia may find they need to be less accommodative to keep inflation in check and to keep in step with the changes in the US monetary policy. That said, Zveglich points out, the chance of another "taper tantrum" is limited as the direction of the Fed’s stance is clearly communicated and the region’s economic fundamentals remain strong.

Dominant segment

Government bonds remained the dominant segment in the emerging East Asia LCY bond market in the third quarter of 2021, increasing 3.9% from the previous quarter to US$13.6 trillion. Government bonds in the Asean member-countries collectively stood at US$1.9 trillion, up 3.6% from the second quarter of 2021 and 14.4% from the same period a year ago. More than 60% of the government bonds in Asean markets carried maturities of five years or longer at the end of September.

On the other hand, the outstanding amount of LCY corporate bonds in emerging East Asia amounted to US$8.2 trillion at the end of September, posting a quarter-on-quarter increase of 2.8%. Domestic investors remain important players in the LCY bond markets of emerging East Asia. Financial institutions such as banks, insurance companies, pension funds, and mutual funds, held an aggregate 51% of the outstanding government bonds in the region at the end of September.

Meanwhile, the sustainable bond markets in Asean+3 countries continued to expand to reach US$388.7 billion at the end of September. In the first three quarters of 2021 alone, the issuance amounted to US$165.5 billion. The Asean+3 is home to the second largest regional sustainable bond market in the world after Europe, accounting for 19.2% of the total global sustainable bond volume at the end of September.

Green bonds, social bonds and sustainability bonds accounted for 71.6%, 13% and 15.3% of the Asean+3 sustainable bonds outstanding, respectively. While the financial sector continued to be a major player in the sustainable bond market in the region, a more diversified issuer base is emerging as the market develops, according to ADB.

Largest market

China continued to be the largest LCY bond market in emerging East Asia with an outstanding volume of U$17.2 trillion at the end of September, or a market share of 78.9%. Both the government and corporate bond segments recorded stronger growth, with the expansion in the government bond market driven by the robust issuance of sovereign debt as the central and local governments continued to raise funds to support economic activity and roll over maturity debts. 

The growth in China’s corporate bond market was fuelled by the issuance of new corporate debt, which remained strong despite the risks brought about by the China Evergrande crisis that unfolded in the third quarter.

In terms of foreign investors’ holdings, their share in LCY government bonds was down in all emerging East Asian markets in the third quarter of 2021, except in China. ADB says the anticipation of policy rate normalization in the US and other developed economies may have influenced the repositioning of offshore funds. The prospects of weaker regional currencies arising from an imminent tapering of monetary stimulus by the Fed may also have affected foreign holdings. Moreover, the Covid-19 situation, while improving, continues to subject the recovery prospects to uncertainty on risk of new waves of infection.

Indonesia and the Philippines had the largest declines among the markets that experienced lower share of foreign investor holdings of LCY government bonds. The share in Indonesia fell 1.3 percentage points to 21.6% at the end of September, while the share in the Philippines dropped 0.9 percentage point to 1.6%.