The bullish fundamental case for Asia ex-Japan debt should be tempered by fears of illiquidity. SIMON MUMME reports. In late September, the worsening Eurozone debt crisis spurred global investors to stage a dramatic sell-off in one of the strongest local-currency debt markets in Asia this year: 10-year Indonesian sovereign debt. By October 6 they had unwound positions worth about $3.8 billion, according to Bloomberg. Even though local buyers, including Bank Indonesia, intervened by purchasing approximately $2.5 billion in the long-dated securities to support falling yields, the sell-off showed one of the major risks for investors in Asia ex-Japan debt: illiquidity. Christopher Watson, head of research at emerging markets funds manager Finisterre, says the episode is a “classic microcosm” of the dynamics of the debt markets of emerging Asia.
“The long end of Indonesian sovereign debt is attractive, yes,” he says. “But is it a smart trade when almost 100 per cent of it is owned by foreign investors?” There may have been enough buyers to allow foreign investors to make a smooth exit and support the strong performance of 10-year Indonesian sovereign debt, which yielded 6.55 per cent at October 13 (see figure 1). But this will not always be the case, Watson says, particularly because Indonesian banks, which account for the majority of local investors, prefer short-term sovereign debt. Despite being underpinned by strong economic fundamentals, Asia ex-Japan debt markets are too illiquid to be considered “safe havens” in which investors can take shelter from the ongoing problems in Europe and the US, Watson says. “There is a fundamental, long-term reason to be very optimistic about Asian debt markets full-stop,” he says. “Our concern is that people looked at them and said how they are decoupling.
The reality is that these markets are very much less developed from a liquidity perspective than other fixed income markets – particularly those that would be called safe havens.” Investors should not be awestruck by the economic fundamentals and remember that Asia ex-Japan debt markets can be rough places to invest. “Indonesia is an amazing prospect. But from an investment perspective you have to be very careful because the door to get in is a lot bigger than the door to get out,” Watson says. “Its fundamental economic trajectory is positive, and government policymaking is reasonably good. Nonetheless, Indonesia remains a quintessential emerging market.” Indonesia has “widespread poverty, inequality of wealth distribution and an opaque financial system somewhat tilted towards vested interests”, Watson says, alluding to the political sway of oligarchic business empires in the nation.