Dollar funding from Asia is under threat in the face of rising risk in the US economy while the region’s primary debt markets led by China thrive as structural change emerges, rooted in sustainability. By Jonathan Rogers.
As annual offshore G3 bond issuance from Asia (ex-Australia and Japan) contracted for the first time in a decade in 2022 while issuance in local Asian currency surged and the offshore primary renminbi markets exceeded issuance in dollars for the first time, market participants pondered a question: is this representative of an axiomatic shift in the “big picture”?
One answer is that it is just temporary and based on an inauspicious US interest rate dynamic in the face of Federal Reserve monetary tightening. The other is that it is about something more, rooted in an array of factors including sustainability, the rise of China and a decline in global dollar hegemony and points to a rebalancing of the debt market status quo.
The numbers from Asia – referring to Emerging East Asia comprising China, Hong Kong, Indonesia, South Korea, Malaysia, the Philippines, Singapore, Thailand and Vietnam – are stark. According to data from the International Capital Market Association, G3 offshore issuance volume from Asia declined 44% last year from the record US$610bn printed in 2021 to US$346bn, a level last hit in 2015.
“Behind the headline numbers, issuers, confronted with the higher cost of issuing bonds in G3 currencies this year, tended to diversify into other funding sources including bank loans and the domestic bond markets and tap the international bond markets with shorter tenors, waiting for more clarity on the rate hike schedules,” wrote ICMA in its quarterly report, published in March.
In the SSA space, according to Refinitiv data, total offshore dollar issuance from Asia (ex-Australia and Japan) declined from US$63.9bn in 2021 to US$44.3bn last year.
Meanwhile, local currency issuance from Asia surged to its highest level in a decade in 2022, clocking up US$2.65trn, according to Refinitiv data, for a 10% increase over the previous year. Some 47.2% of this issuance came from the region’s sovereigns, while the bulk of the remainder was brought by banks and financial companies, comprising 31.2% of the total.
Looking forward, Asia’s economic backdrop is auspicious: Morgan Stanley in April forecast that the region’s growth could outpace developed countries’ by 5% by the end of this year, thanks to China’s post-Covid reopening, strong domestic demand and a positive regional rates backdrop.
“Lending standards will tighten in the US and Europe, and, in turn, weigh on domestic demand,” wrote the bank's chief Asia economist, Chetan Ahya, in a research note. “We think Asia will … be able to generate sufficient domestic demand … to continue to allow growth differentials to shift in favour of Asia.” As a full-blown banking crisis looms in the US, that first point appears apposite.
Meanwhile, if Asia manages to produce this outperformance – which would be the highest since 2017 – and does so against a backdrop of falling inflation, the outlook for Asian local currency debt issuance is pristine.
In its Asian Development Outlook, the Asian Development Bank in April forecast that regional inflation will moderate from 4.4% in 2022, to 4.2% in 2023 and 3.3% in 2024, gradually moving to pre-pandemic averages. Such a dynamic would allow a reversal of the policy rate tightening which occurred across much of the region last year.
This must be put in the context of the region’s need for massive financial resources mobilisation for investment in climate-resilient, sustainable infrastructure to meet its sustainable development goals and those of the Paris Climate Accord.
According to the ADB, Asia’s developing economies need US$1.7trn a year investment in energy, water, transportation, telecommunications and sanitation – sustainable finance on a massive scale is needed if the region is to achieve net zero targets that have been adopted by a growing number of countries.
Staying local
Asia is leaning more and more towards funding its sustainability needs in local markets at the expense of dollar markets: according to Refinitiv, ESG-focused bond issuance in Asian currencies hit US$73.5bn-equivalent last year, up from US$57bn-equivalent in the prior year, with US$16.3bn printing so far in 2023 across green, social, sustainability and sustainability-linked bonds.
“Many developing countries have nationally determined contributions under the Paris Agreement where their climate mitigation plans are largely unfunded,” said Nneka Chike-Obi, head of APAC ESG ratings and research, Sustainable Fitch, in Hong Kong.
“India's National Development Council estimates the country requires US$2.5trn to finance the climate transition until 2030. Sovereign green bonds are one tool to address these significant financing gaps.”
Meanwhile, a beacon for local currency issuance in Asia is the development of multilateral payment systems and fintech-driven alternatives to traditional primary bond issuance and trading. The G20 in late 2020 endorsed a roadmap for enhancing cross-border payments that was drawn up by the Financial Stability Board in order to address weaknesses in the CBP system, including high costs, low speed, limited access and insufficient transparency.
In Asia, this resulted in Project Dunbar, led by the BIS Innovation Hub and including the Reserve Bank of Australia, Bank Negara Malaysia and the Monetary Authority of Singapore, which aims to develop multilateral payment systems using CBDCs and virtual currencies.
Token issue
The HK$800m (US$102m) tokenised green bond issued by Hong Kong in February emerged from groundwork laid by Project Dunbar, representing the world’s first digital green bond and opening the door for further distributed ledger technology issuance using the blockchain, where the focus will be on sustainable – primarily green – issuance.
“Green tokenised issuance may offer some new ways to improve settlement efficiency, reduce operational risk, and automate disclosure. In any case, for a truly digital bond, CBDC issuance is likely to be necessary in some form as those digital forms of exchange go mainstream,” said Mushtaq Kapasi, chief representative, Asia-Pacific, of ICMA in Hong Kong.
A new financing ecosystem centered on green products distributed in new ways beckons and, given Asia’s massive infrastructure funding need and commitment to Paris Climate Agreement obligations, a virtuous circle scenario emerges.
Meanwhile, Hong Kong last May tapped the increasingly weighty local currency retail bid with a HK$20bn (US$2.5bn) three-year and Malaysia opened the ringgit-denominated green sukuk space in September with a M$4.5bn (US$969m) 15.5-year.
And the Monetary Authority of Singapore led an innovative charge in the domestic direction last August with the first 50-year green bond to be issued by a sovereign with a S$2.4bn (US$1.7bn) zinger which pushed the city-state’s local currency bond market out beyond 30 years and provided a long-tenor pricing benchmark for other Singaporean issuers.
“It makes sense for sovereigns in these markets to provide high-quality liquid supply and uncover the nascent bid, which may include a strong retail component, and create benchmark curves for other domestic issuers,” said ICMA’s Kapasi.
Indeed, Fitch’s Chike-Obi suggests Asia’s sovereigns are using sustainable issuance as “a tool to both contribute to environmental policy goals and to diversify their domestic capital markets”, and notes that “the governments of Singapore and Hong Kong have explicitly said that their own green bonds are part of plans to create a green finance infrastructure in their financial sectors”.
Showing initiative
The need to develop Asia’s local bond markets was recognised via the establishment in 2003 of the Asian Bond Markets Initiative, which aims to develop liquid, efficiently functioning domestic bond markets in South and East Asia.
That initiative was seeded by the shock of the late 1990s Asian Financial Crisis, when the region was punished for its reliance on short-tenor US dollar debt, and its aims have been and continue to be achieved. According to the ADB, for emerging and developing Asia, the total external debt burden as a share of GDP was around 18% – mostly dollar-denominated – versus 48% for Latin America and 40% for Sub-Saharan Africa, and local currency issuance in the region has grown rapidly.
A fascinating development within emerging East Asia has been the growth of cross-border bond issuance, wherein countries in the region issue in neighbouring local currencies. Cross-border regional issuance in the fourth quarter of 2022 reached US$12bn-equivalent, for a surging 46% quarter-on-quarter gain on the previous quarter, with issuance dominated by the Republic of Korea, which brought bonds in renminbi as well as in Hong Kong and Singapore dollars.
In the process, such issuance enables the region’s growing pool of savings to be put towards efficient use – particularly into urgently needed infrastructure and with a keener eye on sustainability and climate change mitigation than was manifest when the ABMI was established 20 years ago.
“In the broader Asia and Pacific region, green, blue and sustainability bond issuance is a major focus for public debt managers, since climate change is a clear and present danger for regional economies and livelihoods,” said Jonathan Grosvenor, assistant treasurer at the ADB in Manila. ”The elusive greenium is rarely the pull factor, instead the major drivers being the ability to tap into a new universe of dedicated ESG investors whilst extending maturity profiles.”
As of early May, a snapshot of US debt markets is not a pretty picture: the US Treasury is set to run up against the debt ceiling as early as the beginning of next month, the cost of insuring against US default, has risen to its highest point since 2012 – gaining 132bp in the month prior to May 3 – the stocks of mid-sized US banks have plummeted even though First Republic Bank was rescued by JP Morgan, threatening a full-blown banking crisis, and the Federal Reserve has tightened rates again as core US inflation remains high and the jobs market tight.
Seeking insulation
At the chaotic peak of the risk-off mindset precipitated by Silicon Valley Bank’s demise in March, high fund flows to Chinese sovereign fixed-income assets supported a theory that fast became fashionable: they represent a safe haven of low correlation to all the dollar-denominated drama. And China’s “internal circulation” growth model, low inflation and relatively loose monetary stance wherein macroprudential policies are favoured over policy rates and reserve requirements suggests ongoing insulation from Stateside turmoil.
Still, foreign investors curbed their exposure to Chinese fixed-income assets last year even though the asset class outperformed other global bond markets and hedging the renminbi against the US turned net positive in early June for the first time in two years.
Big-picture thinking puts that theory into the same basket that contains items such as the likelihood that China will overtake the US to become the world’s largest economy – the IMF predicted in a research note in early May that this would occur by 2028 – and that such a realised trajectory would by rights see the Chinese government bond market displace the US Treasury bond market as the world’s debt benchmark.
China’s offshore renminbi market delivered a remarkable performance last year, driven by an auspicious low volatility rates backdrop which enabled international issuers to meet competitive funding targets.
According to Refinitiv data, Dim Sum issuance clocked a heady US$47bn-equivalent last year via 470 deals – of which US$12.4bn came from the SSA sector – the highest volume since 2014, and exceeding US dollar offshore issuance by almost US$3bn. So far this year, momentum has continued: US$16bn-equivalent of Dim Sum paper printed in the first quarter.
The internationalisation of the renminbi is aided by the deepening of the onshore bid thanks to the growth of pension, insurance and other funds as well as banks and retail, and the offshore bid, which appears to be demonstrating a secular strengthening.
This internalisation has gathered pace over the past 15 years: China can settle trade in the currency with over 100 countries and, according to Standard Chartered Research, in the first nine months of last year, 43% of China’s total cross-border transactions were settled in renminbi. Trade financing data from Swift show the renminbi’s share of trade finance has doubled since the invasion of Ukraine, from 2% to 4.5%, and is advancing on the euro’s 6% of global trade financing.
Domestic renminbi bond market growth can be explained by a raft of factors, including the ease of access to China’s domestic debt markets via the Hong Kong Bond Connect platform inaugurated in 2017– soon to be complemented by the Swap Connect platform – the low correlation of China’s government debt markets to the price action of the US’s, bank crises included, and the facilitation of the offshore bid by foreign investment banks in China which have migrated to full ownership of the JVs they set up with Chinese firms around a decade ago.
Other structural reforms designed to encourage foreign capital into China’s debt markets include the ability to trade bonds on the exchange market for qualified foreign institutional investors, granted by the PBoC and the China Securities Regulatory Commission in May 2022. Hedging via derivatives was also allowed.
Another boost to the internationalisation of the renminbi came last in March when Chicago’s CME Group opened options trading in the Chinese unit.
A multipolar currency system is emerging and the dollar’s role as the default payment currency for global trade is under threat. The implications for debt capital markets appear profound – particularly from the perspective of Asia – as a new digitally driven currency-diverse issuance ecosystem rooted in sustainability threatens to emerge.
The dollar might not be about to imminently lose its pre-eminent reserve currency status, with all the privileges that brings, even though the US unit’s share of global central bank reserves has fallen from 72% in 1999 to 59% last year, according to IMF data.
China’s relatively closed capital account explains why the renminbi’s reserve share has remained fairly constant over that period, at around 6% (a third of that is held by Russia) while reserve holdings of stable, high-yielding currencies such as the Australian and Canadian dollars and the Swedish krona and South Korean won have increased, aided by the use of financial technology in managing central bank liquidity.
Hostages to fortune
In the midst of the Federal Reserve’s rate tightening campaign – the 10th consecutive Fed funds increase was delivered in early May – many of Asia’s countries may feel hostages to fortune of US monetary policy at a time when fundamentals suggest a divergent interest rates trajectory is appropriate in the region.
“The US dollar plays a far too dominant role in global finance,” wrote former Goldman Sachs chief economist Jim O’Neill in a paper published by Global Policy in March. “Whenever the Federal Reserve Board has embarked on periods of monetary tightening, or the opposite, loosening, the consequences on the value of the dollar and the knock-on effects have been dramatic.”
Meanwhile, weaponisation of the dollar in the form of the freezing of Russia’s central bank reserves and the cutting off of the country from the Swift payments system has hardened the resolve of the key actors – China, Russia, India and Brazil – to look for dollar alternatives.
Momentum was already there in the fast-moving projects to launch central bank digital currencies, while the BRICS block – comprising those four countries plus South Africa, into which entry is being sought by a growing list of aspirants including Argentina, Egypt, Indonesia and Saudi Arabia, “BRICS Plus” – is talking of launching its own currency. An announcement may come as early as August, when the annual BRICS meeting is held in Durban.
“Every night I ask myself why all countries have to base their trade on the dollar,” newly elected president of Brazil Luiz Inacio Lula da Silva said in a speech addressing the New Development Bank in Shanghai during a state visit to China in April. The NDB is referred to as the “BRICS bank”, given its share ownership and mission; it has been helmed by former Brazilian president Dilma Rousseff since March. “Why can’t we do trade based on our own currencies?” he added, to loud applause.
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