Developing Bond Markets in Asia^*

October 2009
Center for Monetary Cooperation in Asia, International Department, Bank of Japan

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Summary

1. In retrospect, the prevailing argument for developing local currency bond markets in Asia as a prescription for the Asian crisis is not necessarily solid.  The argument has some logical weakness with regard to the envisaged impact of developing bond markets, and sometimes lacks sufficient empirical evidence on the causes of the crisis.
   
   
2. Looking at the bond markets in Korea, Thailand, Malaysia and Indonesia since the Asian crisis, while public bond markets have expanded significantly, led by both government bond and central bank debt, the development of corporate bond markets has been limited.  In the meantime, the share of local currency denominated bonds has risen.
   
   
3. The limited development in corporate bond markets was a key factor hampering the achievement of the policy goal of developing bond markets as a prescription for the financial crisis.  In particular, little progress has been made with regard to a) lessening over-reliance on capital flows, and b) a shift from a bank-centric finance system to a twin-engine system with corporate bond markets as an alternative financing channel.
   
   
4. On the other hand, it appears that significant progress has been made since the Asian crisis in the management of the various risks associated with capital flows, including the double mismatch of currency and maturity.  This progress was attributable to improved risk management capacity and better regulatory and supervisory frameworks, as well as better macroeconomic policy management, especially more flexible foreign exchange (FX) policy.  Such improved risk management appears to have contributed to the limited impact of the recent global financial turmoil on the financial stability in the region.
   
   
5. As for the reason for the limited development of corporate bond markets, real economy factors, especially limited long-term financing needs of large corporations with access to bond markets, might be more significant than financial impediments such as insufficient market infrastructure. This can be seen from the fact that bank lending to large corporations has also been stagnant.  In addition to stagnant growth in investment in the region and changing industrial structure, the relatively large role of equity financing and internal funding, especially in the case of FDI-related companies, might be significant in explaining the limited demand for corporate bonds and bank lending.
   
   
6. The importance of developing local currency bond markets has been discussed with too much emphasis on its role as a prescription for the Asian crisis - an approach which has been critically examined in this report.  Still, the importance of such markets remains in a broader sense as they contribute to more market-oriented interest rate formation, more efficient resource allocation, and the establishment of a transmission mechanism of monetary policy.  In this regard, expansion of public bond markets is welcome, but the remaining challenge is to promote secondary markets by enhancing market liquidity and broadening the domestic investor base.
   
   
7. Regional financial cooperation to promote the development of Asian bond markets has so far made progress in broadening the investor base globally and removing impediments in the market infrastructure. Should long-term financing needs in the corporate sector gradually materialize in the coming years, reflecting changes in economic and industrial structure, it is expected that regional financial cooperation will bear more fruit in the form of the development of corporate bond markets.