Already one of this year’s most embattled asset classes, emerging markets debt, could face more pain. At least that could be the case for bonds from region’s issuers as the Asian Development Bank sees lingering risks for debt issued by Emerging East Asia issuers.
While the ADB noted in its Asia Bond Monitor report released Thursday that countries in the region are in a better position today than during the Asian financial crisis of the late 1990s, emerging Asian economies remain vulnerable to the loss of U.S. stimulus. Mere speculation and talk of tapering of the Federal Reserve’s quantitative easing program is one reason the WisdomTree Asia-Pacific Local Debt ETF (NYSEArca: ALD) and the Market Vectors EM Local Currency Bond ETF (NYSEArca: EMLC) are down 5.6% and 7.9%, respectively, this year. [Taper Talk Pummels Local Currency ETFs]
“Growth in the region had been fueled by the easy availability of credit, which will now become more restricted,” the ADB said in the report. “Rising levels of corporate indebtedness also suggest that the impact of higher interest rates on the economy may be intensifying.”
ADB classifies the following countries as Emerging East Asia: China, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Thailand and Vietnam. Hong Kong and Singapore are AAA-rated developed markets and South Korea is viewed as a developed market by some index providers, but ADB still highlighted several risks that could affect the region’s local currency bonds.
“Yet, risks to the region’s bond markets are intensifying. Specifically, (i) the region’s interest rates could rise further when the Federal Reserve starts to tighten policy; (ii) weakening growth momentum in the region could accelerate the pace of capital outflows; and (iii) continued outflows could result in vulnerable economies raising interest rates to prop up their currencies, thereby further dampening growth,” said ADB in the report.
Local currency bonds issued by the Philippines and Vietnam, as two examples, could prove somewhat durable because those countries currently sport account surpluses. On the other hand, Indonesia’s current account deficit is seen as problematic for that country’s bonds. [Indonesia ETFs Lead Global Sell-Off
The $500.9 million, actively managed ALD could endure potential suggest to Asian bonds because nearly two-thirds of the funds holdings are rated AAA, AA or A. Additionally, the ETF is not focused solely on emerging Asia as AAA-rated Australia and highly-rated New Zealand combine for over 17% of the fund’s weight.
EMLC is not heavily allocated to Emerging East Asia, but the fund does allocate a combined 23.5% of its weight to bonds denominated in the Malaysian ringgit, Indonesian rupiah, Thai baht and the Philippine peso.
Despite the cautious view from the ADB, not all market observers are bearish on emerging markets debt. Some even see opportunity.
While we acknowledge that growth has slowed in many emerging markets as of late, we believe that current exchange rates do not accurately reflect the long-term potential of many of these economies. In many instances, EM currencies are now trading at multi-year lows against the U.S. dollar. Additionally, with only a single exception (the Chinese yuan), EM currencies continue to trade well off their high water marks set in 2006,” said WisdomTree portfolio manager Rick Harper in a note out Wednesday. [WisdomTree: More Opportunities in Emerging Markets Fixed Income]
ETF Trends editorial team contributed to this post.