KUALA LUMPUR (Nov 25): Emerging East Asia’s local currency bond markets are resilient but a faster-than-expected US interest rate hike and a stronger dollar could pose problems, according to the Asian Development Bank (ADB).

In its latest latest Asia Bond Monitor. Head of ADB’s Office of Regional Economic Integration Iwan J Azis said higher US rates and a stronger dollar could prove to be a challenge given increased foreign holdings of Asia’s bonds, which could easily reverse, and record US dollar bond issuance by the region’s companies.

He said the US dollar debt becomes more expensive to service in local currency terms when the dollar appreciates.

The quarterly report noted other challenges from tightening liquidity in the region’s corporate bond markets as Basel III requirements deter banks from holding large bond inventories, and a weaker property market in the People’s Republic of China (PRC), given many property developers there are highly indebted.

Accodring to the Bond Monitor, markets were currently anticipating that the US Federal Reserve will increase interest rates in June 2015 but recent economic data suggested the economy was improving faster than anticipated.

“The US dollar, meanwhile, has appreciated against most emerging East Asian currencies recently, and monetary tightening would likely see it rise further,” it said.

The report added that foreign holdings remained stable in most of emerging East Asia in the third quarter of the year although they ticked up in Malaysia and hit record highs in Indonesia.

“At the end of June, the share of foreign investment in Malaysia’s government bonds was 32.0% versus 30.8% at the end of March.

“In Indonesia, foreign investors held 37.3% of outstanding sovereign bonds at the end of September, up from 35.7% at the end of June,” it said.

The report said that meanwhile, borrowers from emerging East Asia sold $143.5 billion in US dollar, euro, or yen-denominated bonds in the first nine months of 2014, a new annual record and surpassing the $141.5 billion issued in the whole of 2013.

It said China was the largest issuer so far, selling $65.9 billion – or 46% of the total – followed by the Republic of Korea which sold $26.3 billion, led by financial institutions.

The Bond Monitor said despite the risks, emerging East Asia’s local currency bond markets continued to expand.

It said that by Sept 30, there were $8.2 trillion in such bonds outstanding, 3.1% higher than at the end of June and 11.3% more than a year earlier.

The fastest-growing markets on a quarterly basis were Singapore, China and Indonesia, it said,

The report said an annual liquidity survey of the region’s local currency bond markets showed that liquidity conditions have improved in 2014 compared with 2013, although liquidity in government bonds far outpaces that of corporate bonds.

“Bid-ask spreads, which tend to be narrower in liquid markets, were lowest in Korea, followed by Malaysia and Thailand,” it said.

“Respondents to the survey said key constraints to market liquidity are still a narrow investor base, foreign exchange regulations, tax treatment, the lack of instruments for hedging and for transaction funding, and low transparency,” said the ADB report.