Asian bonds herald change in outlook

June 7, 1999 -- DURING this time last year most people believed that a recovery might not happen in Asia easily, or that Asia, following a crash in 1997, could at best manage to reach a plateau before falling another step down.

But now the perception has changed as judged by the positive response in the bond market for Asian sovereign issuers. The spreads of Asian bonds that used to peak at around 900 basis points above US treasuries has narrowed significantly. The US$600-million Kingdom of Thailand bond is now trading at a spread of 215 basis points, compared to 222 basis points and 225 basis points for the South Korean bonds.

Stephen Taran, managing director and global head of sovereign risk research at Salomon Smith Barney, says due to the illiquidity of the Thai sovereign bond, the spread is narrower than it should have been. If the Thai government is to launch a global bond now, it should fetch a spread of about 253 basis points -- or pay a higher premium than the Korean bonds, which have a better credit rating.

Overall, he believes that Asian sovereign bonds have received positive response from the markets because the economies have stabilised and recovery is back on track.

Yet the world is still a risky place, which will put a premium on Asian paper. Ever since the US Federal Reserve Board signalled its tightening bias towards monetary policy there have been jitters over a possible sell-off on the New York stock market. If that is to happen it will directly hit the pockets of US consumers. The ensuing credit crunch will certainly slow down US growth, the only locomotive that is pulling the global growth.

However, Taran says Asian sovereigns still have ample access to the global bond markets. The global risks mean that spreads are going to move more sideways than down as the Asian countries await a better credit upgrading by the end of 1999.

Thailand, in particular, is not likely to get an upgrade to investment grade of its sovereign bonds by either Moody's Investors Service or Standard and Poor's by 2000. The two rating agencies would like to see more evidence of improvement in the external account, bank and corporate restructuring and the implementation of economic laws covering corporate debt settlements before they decide on the upgrade.

Despite the junk status of its bonds, it does not mean that Thailand cannot issue bonds, for the question is the premium. Dr Mahathir Mohamad, the prime minister of Malaysia, recently decided to launch a US$1 billion bond to prove that Malaysia could raise money from the global markets in spite of an absence of a credit upgrading from Moody's. The issue, arranged by Salomon Smith Barney, paid an expensive premium of about 330 basis points above US treasuries.

Last week Eisuke Sakakibara, Japan's vice finance minister, held talks with Tarrin Nimmanahaeminda, the Thai finance minister, in Bangkok. One of the topics raised by the Thai side was the possibility of Thailand tapping the Miyazawa Fund to guarantee its sovereign bond.

Sakakibara is keen to bolster the status of the yen as a regional currency to counter the dominance of the US dollar and the euro. The Thai sovereign bond, if launched under the auspices of the Miyazawa Fund, will have to be denominated in yen -- not US dollars. A guarantee from the Miyazawa Fund means that the Thai bond should only pay a very tiny premium.

In his study of six Asian countries -- China, Indonesia, Korea, Malaysia, the Philippines and Thailand -- Taran finds that the crisis in these economies has bottomed out and that they are on their way back to positive territory after two years of severe recession. However, growth will be driven largely by domestic demand. Improvement in consumer sentiment in Thailand and the fiscal stimulus hold the keys to positive growth. Investment, which accounts for 25-30 per cent of Thailand's gross domestic product, will only recover slowly, the same situation with other neighbouring countries which are still saddled by overcapacity.

The positive result from this slowdown is the external account stability. From a current account deficit, financed by foreign funding, Thailand and other countries -- except China which has been posting a surplus -- have a current account surplus. Foreign-exchange reserves, as a result, have been built up to stable conditions. Short-term debts have decreased significantly.

The theme for Asia is corporate and financial restructuring, a period that companies and banks have to go through amid sluggish demand. Taran says unlike Latin America, Asia is likely to bounce back.

This year has been a difficult one for several Latin American countries. They are in recession and their current accounts are in deficit. While Asia has the capacity to go for fiscal deficit to fuel growth there is little room left for Latin America to resort to deficit financing, which will spook financial markets and will be resisted by the International Monetary Fund. Political pressure on Latin America will be greater.

In the summer of 1998, Asian and Latin American bond spreads converged to share the same premium. But as of May, Asian bonds are trading at 300 basis points lower than Latin American bonds.

Although ample liquidity in the domestic market makes it unnecessary for the Thai government to do a global bond offering to raise liquidity, it might need to do so as a demonstration of its ability to re-access the global bond markets. This will fuel greater investor confidence.

Taran says access to bond markets will feed the virtuous cycle -- external capital flows, currency stability, lower domestic interest rates, economic recovery and access to foreign capital.

BY THANONG KHANTHONG