Sell-off sparks fears for Asia
(This story was originally published in IFR Asia edition 810, a Thomson Reuters publication, on August 24.)
* Capital outflows close funding markets across Asia
* Asian companies are the world's most leveraged -analyst
* Default rates expected to rise in the region
By Steve Garton
HONG KONG, Aug 26 (IFR) - An emerging-market sell-off took on a far more ominous tone last week in Asia as investors slashed their exposure to the region's most vulnerable economies.
India and Indonesia bore the brunt of the pressure as investors abandoned the countries with the worst current account deficits, but the storm soon reached the Philippines and Malaysia.
Credit spreads spiralled, and currencies and stocks tumbled, leaving even the most optimistic investor worrying about a funding crisis among the many companies that have come to depend on regular access to the capital markets after a funding spree in recent years.
"Deteriorating cash generation and adverse borrowing conditions on already leveraged balance sheets open up a new downside scenario," said Viktor Hjort, head of Asian fixed-income research at Morgan Stanley.
"A steady rise in leverage in recent years means Corporate Asia now has the most leveraged balance sheets globally. Those balance sheets face a combination of slower growth and higher funding costs."
Rating agency Fitch said it planned no action on either India or Indonesia, but noted that a "broader and sustained loss of confidence among investors" could undermine economic stability.
Indonesia's main share index slumped 9% in the first two days of last week, while the Philippines equivalent tumbled 6% last Thursday after a three-day holiday. The rupiah slid 4.1% against the dollar and the Indian rupee lost 4.7% in the first four days of the week. Malaysian five-year CDS jumped 15bp on Thursday to a 21-month high as the ringgit came under pressure, touching a three-year low against the dollar.
Higher US Treasury yields and soaring credit spreads added to the pain for companies with US dollar liabilities. Ten-year Treasuries spiked again last week to almost 2.9%, up from 1.62% in early May, on renewed expectations that the US will scale back its bond purchases sooner rather than later.
Credit spreads for Indian banks spiked early in the week, with State Bank of India five-year CDS, widely seen as a proxy for the Indian sovereign, trading at 351bp on Monday, up 45bp on the day. Indonesia five-year CDS also surged to a high of 277bp last Thursday, up from 205bp on August 15, according to Markit prices.
Local markets are offering little respite from the higher funding costs. The yield on India's 10-year government benchmark reached 9.26% early last week, its highest since August 2008, shortly before the collapse of Lehman Brothers. The 10-year Indonesian rupiah benchmark hit 8.45% last week, its highest since March 2011.
Asia's local funding markets have collapsed due to capital outflows since May 1, with new issue volumes down sharply in all currencies versus the same period last year. Bond sales in rupiah, Hong Kong dollars, Singapore dollars, Philippines pesos and Malaysian ringgit are all down at least 50%.
Tighter credit conditions and slumping currencies are raising fears of a rise in default rates among the region's dollar borrowers, reminiscent of the Asian financial crisis that followed a rout of South-East Asian currencies in 1997. While analysts believe the region is in far better shape than 16 years ago, tighter bank lending is adding to the challenges.
Bumi Resources, Hidili, Winsway Coking Coal and Mongolian Mining Corp have all been downgraded to Triple C in recent weeks. Morgan Stanley predicts a 1.8% default rate in Asia in the next 12 months, up from its 0.8% forecast as of December.
India Ratings & Research, Fitch's local arm, said last month that the debt-servicing ability of India's BSE 500 listed companies was at its weakest since 2008.
Analysts see the next 12 to 18 months as the most challenging business environment for Indian corporations since 2000, in part due to elections due by May 2014, but also because of uncertainty surrounding an end to the US Federal Reserve's quantitative easing.
"My worst-case situation is if the Fed starts tapering the QE3 only in and around the general elections in India," said Deep N Mukherjee, head of the corporate group at India Ratings.
While investors acknowledge that weaker currencies and a stronger US recovery will help exports, last week's price movements show the focus remains firmly on the need for structural reforms.
On Friday, Indonesia unveiled measures to reduce imports and boost investment. The emergency fiscal package is aimed to strengthen the current account. The new policy will see an increase in import taxes on luxury goods and tax incentives for labour-intensive industries. The central bank will also ease restriction to ensure banks and exporters have access to dollar funds.
"The sell-off in Indonesian debt is exaggerated. Fundamentals have not deteriorated to the extent suggested by the prices," said Anthony Chan, analyst at AllianceBernstein Fixed Income. "The market has indiscriminately penalised Indonesia along with India."
Amid the gloom, investors were still watching out for bargains. Credit markets began to stage a recovery towards the end of last week, with the Philippines' 2032 note, for example, up 0.75pts on Friday, according to Tradeweb, while the long-end of even Indonesia's curve was performing better with the sovereign's 2042 notes also up 0.75pts.
"I think a few investors feel they sold out too cheaply in the last couple of weeks and are now coming in to cover some more shorts," one trader said. (Reporting By Steve Garton, additional reporting by Umesh Desai, Manju Dalal and Sudip Roy; Editing by Matthew Davies)
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