How Higher U.S. Rates Affect Asian Bond Markets

  • Higher global interest rates and depreciating currencies push up borrowing costs and debt servicing obligations for Asian governments and corporates.

  • Foreign currency borrowing is still perceived as a risk to Asia’s economic and financial stability.

  • Capital inflows linked to easy global monetary settings have lifted foreign ownership rates in Asia's local currency bond markets.

  • Strong growth in local currency bond markets helps to reduce liquidity concerns, exchange rate risk, and the threat of financial turmoil.

Global monetary easing since 2008 has driven an inflow of capital into Asia, helping to fund investment while pushing down borrowing costs for governments and corporates. However, an end to these easy monetary settings is near, with higher U.S. interest rates on the horizon. We've already had a sneak peak of how this shift may play out; a selloff in financial assets from mid-June through August lifted bond yields in the U.S. and Asia and caused Asian currencies to depreciate.

Higher interest rates and depreciating currencies push up borrowing costs and debt servicing obligations for Asian governments and corporates. Indian and Indonesian central bankers are pushing up local policy rates to try to shore up currencies, though this action risks choking economic growth. Current account imbalances and a relatively high exposure to external debt leave India and Indonesia the most susceptible to the whims of investors.

The next step is to examine how much of Asia's debt is denominated in foreign currency as well as the rate of foreign ownership in local currency bonds to help assess which governments and corporates are vulnerable to exchange rate risk and a repatriation of funds as global monetary conditions tighten.

Foreign currency debt

Excessive foreign currency borrowing was a key contributor to the 1997-1998 Asian financial crisis, and is still perceived as a risk to Asia’s economic and financial stability. As was the case in 1997, foreign currency borrowing brings trouble when local currencies lose value because repaying foreign debt becomes more costly. The value of Asia’s foreign currency bond market (excluding Japan) has doubled from US$380 billion in December 2008 to just over US$750 billion in June. Since then Asian corporates, in particular, have taken advantage of low interest rates in the U.S. and taken out foreign loans rather than issue bonds at higher local rates. Strong overseas demand for higher-yielding Asian securities and underdeveloped local currency bond markets has also driven this trend towards foreign currency borrowing.