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Safe harbors

16 May 2012 By Wayne Arnold

Asian bonds seem likely to gain from growing anxiety about Europe and China. The region’s robust finances have made its sovereign debt a safe haven as larger economies sputter. An indiscriminate sell-off would hurt everyone, but Indonesia, Japan and the Philippines all have qualities that should give them greater resilience.

Worse-than-expected economic data from China and the prospect of a Greek exit from the euro zone have sparked a stampede from risk assets. Investors fear global growth will slow, and that the sell-off will snowball. One way bleaker conditions in Europe could reach Asia is through its banks. European lenders pulled at least $135.8 billion in credit out of Asia in the second half of 2011, according to the Bank for International Settlements.

Asian sovereign bonds should benefit from weaker growth, lower inflation and lower interest rates. The safest are those that are also less vulnerable to outflows. Indonesia, for example, has public debt of less than a quarter of GDP – even Germany owes three times as much. It has relatively little short-term external debt and a much lower reliance on credit from European banks than other Asian economies. Yet the government’s 10-year bonds yield 4.7 percentage points more than Treasuries.

Japan, despite bonds that yield less than Treasuries and a government debt 1.5 times larger relative to its economy than Greece’s, is safer still. Foreigners own less than 7 percent of its bonds, which limits the potential for forced selling, and Japanese deflation has kept demand steady. By contrast, foreigners hold 80 percent of Australia’s government debt.

The most unlikely refuge is the Philippines. Though impoverished, its government has managed to build a $76 billion foreign reserve buffer, equivalent to almost six times its short-term external debt, and finances 95 percent of its public debt at home. Yet Philippine bonds still pay 4 percent more than U.S. Treasuries. Such trades are still risky – not everyone wants to go long the Philippine peso. But the worse things get elsewhere, the more palatable that risk may seem.


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