Asset price inflation in China is not enough of a concern to negatively impact the country’s long-term credit ratings – yet, a senior officer from Moody’s Investors Service told a forum this week.
Nor is the rating agency expecting to lose sleep anytime soon over the risk of capital outflow from Asia, safe in the knowledge that the region’s fiscal fundamentals are demonstrably sound.
Many of the questions in the opening panel session on sovereign debt at AsianInvestor’s and FinanceAsia’s second Asia-Pacific Debt Investor Forum were directed at Tom Byrne, a senior vice-president and regional credit officer at Moody’s.
But he was not alone. Also on stage was Don Guo (pictured right), executive vice-president and head of investment at Asia Capital Reinsurance Group, and Ray Choy, head of debt markets research for the RHB Research Institute.
Discussion topics ranged from the extent to which sovereign ratings take account of inflation risk, whether ratings are even a key consideration for investors in terms of decision-making and, more pointedly, whether Indonesian government bonds represent a better bet than Ireland's.
Moderator and freelance consultant William Lowndes, most recently head of Asian distribution at Threadneedle, began by asking Byrne to offer his views on the outlook for sovereign bond spreads in Asia.
Byrne noted that over the past year bond yields, and so the ratings implied from bond yields on government bonds and CDS spreads, had not budged for most of Asia, which he said was “surprising in the context of the stress in Europe”. He pointed to Korea and China as examples.
He also pointed to the upward momentum seen on all Asian ratings except for Vietnam, and excluding Japan. “Perhaps this will continue,” he added.
On the question of whether Indonesia or the Philippines would make a better bet than Ireland, Byrne pointed, perhaps diplomatically, to the positive outlook for Asian nations.
“The trends are moving in opposite directions, let me put it that way,” he said. “We do have to take into account the possibility – and it is not as remote as before – of a Greek restructuring and what further affect that would have on Ireland’s access to the market.”
In the case of Greece, Portugal and Ireland, he noted, 70-80% of their debt was external, whereas in Asia it was more like 10% for Korea and 5% for China, Malaysia and Thailand. “The fundamentals in Asia are a lot more stable than we see elsewhere,” he added.
In terms of market indications, Choy (pictured left) said the RHB Research Institute focuses first on CDS spreads, followed by credit spreads and eventually equity prices. He said ratings agencies offered a homogenous product with a forward-looking time-horizon of around three years, and as such would not be able to please the diverse range of investors.
Byrne later suggested Choy was being generous, pointing out that Moody’s medium-term time horizon was just one-to-two years, although it also has a ratings committee with a horizon of up to 5-10 years for advanced economies with detailed data.
From an institutional perspective, Guo said that Asia Capital Reinsurance held a positive view on Asian credit in general, with an overweight in local-currency bonds. “That is where we see the value-add,” he said. “We see the G3 currency bonds as fair value or even overvalued.”
He said the firm constantly takes inflation risk into account and was overweighting countries with positive real yield and a stable or appreciating currency. His favourites are Korea, Malaysia and Indonesia.
“In terms of currency, of course the renminbi is one we are very focused on at the moment,” he added. “But, honestly speaking, we do not like CNH bonds. We have local currency investment in China, which has better carry and benefits directly from China’s economy.”
On the question of whether Asia’s bond markets offered sufficient compensation for the inflation risk, Guo suggested most local currency bonds had already priced in the risk. The danger, he noted, was unexpected inflation, and as a result Asia Capital Reinsurance uses an inflation hedge bucket investing in commodities and commodity-related stocks as well as inflation-linked bonds.
Asked how Moody’s takes inflation into account in its ratings, Byrne pointed out that consumer price inflation tends to affect the credit fundamentals of lower-rated countries more (where inflation rises higher), while asset price inflation hits those at the higher end of the ratings scale.
But he said Moody’s was not yet concerned enough about asset price inflation in China to reflect that in the country’s longer-term ratings. “We think the banks are strong enough to absorb losses in the system without it going onto the government’s balance sheet.”
Responding to a question from the floor on inflation methodology, Byrne said everyone was dependent on national source data for inflation, but added: “We do look to see what the limitations of the national source data are, for example whether there is a lot of commodities whose prices are administratively controlled or whether the basket is out of date.
“But, at the end of the day, no matter where you are, you have to try to interpret what’s out there. You can’t develop your own inflation index.”
He now views it as more important to look at headline inflation, which includes food and energy prices, than core inflation following a decade of rising, high and volatile commodity prices.
Further, amid a generally upbeat view on capital flows into the region, the possibility of an asset flow reversal out of Asia was also raised.
Choy pointed to quantitative easing policies and the availability of funding currencies such as yen and US dollars as a key driver of inflows, but highlighted soft patches in regional economic growth, notably in Japan after the March 11 disaster and recent softness in China PMI readings.
“If you were to look at where US interest rates or monetary policy is going over the next year, most of us are talking about potential reversal of the QE2 program and potentially higher interest rates, perhaps in the second half of 2012 for the US,” said Choy.
“It could result in some reversal of flows out of Asia, but that would be on a slightly shorter-term view. On a macro, longer-term view, we believe the Asian region is still largely underinvested.”
Guo noted that on the capital flow side, institutional investors including sovereign wealth funds and pension funds had increased their investment into Asian bonds, both G3 and local currency.
“If you look at the largest share of bondholders in Korea, it’s China. And we also see China invest heavily in Malaysia as well. So this is a very good stabiliser in the Asia bond market.”