Flush liquidity, healthy operations, low refinancing needs, and limited capital outlays among rated firms will help deleveraging and keep default rates low in South and Southeast Asia. S&P Global Ratings expects these trends to delink the region from China in 2022 and benefit issuers there as investors diversify away from China's speculative-grade markets.

In China, tight liquidity and weak housing markets are squeezing corporates and driving defaults. This is likely to continue despite policy easing under the government's new focus on stability.

India stands in stark contrast. We project absolute debt levels there to fall by 5%-7% on average in 2022 and 2023 for rated issuers, 40% of which will likely have at least 20% less debt at the end of this year than they did in 2020. This would be the lowest level in five years, thanks to a combination of management commitment, limited capital expenditure (capex), and favorable operating outlooks.

In Indonesia, performance will diverge across sectors. Commodities have largely rebounded to pre-COVID levels. Domestic industries face a slower recovery amid the omicron wave and still-volatile consumer sentiment. Ratings are still below pre-pandemic levels, but those with negative outlooks dropped to a third from nearly 60% of the total six months ago. Default risks remain for a few weaker issuers. They will face refinancing risks as well as more selective lenders in 2022.

Here we look at these risks in more detail, addressing some frequently asked questions (FAQs). In a different approach to previous FAQs, we incorporate views from market participants in the region, including those from Schroders Investment Management, HSBC, and Deutsche Bank (DB). These comments were derived from the Asia Corporate and Infrastructure Outlook Conference we hosted on Jan. 25, 2022.

Frequently Asked Questions

What top risks are credit investors focusing on this year?

Lemos-Stein (S&PGR):   The "four horsemen" of credit risk this year are: inflation, labor cost, supply chains, and interest rates. So far these have not impaired corporates globally, but if you have a lot of these for a long time, they can really hurt credit quality.

There's not a great deal of certainty when you're dealing with inflation and interest rates. Central banks have a lot more experience raising target benchmark rates, but deleveraging their own balance sheets is less familiar territory. When you're doing both at the same time, that's a risky proposition. That, I believe, is what's behind some of the volatility in markets recently.

If you get a massive change in the risk premium, and if you have much less confidence and much less liquidity in markets, you might start to see more corporate insolvencies. The number of defaults we're seeing is very low, but we do expect a normalization.

How might these risks affect issuance in Asia this year?

Chia (Schroders):  Many say issuers will rush to issue before rates go up. We found that, over the past 10 years, there is no clear relationship between rising rates and bond issuance. We need to look at why rates are going up. They could be going up due to economic growth, which is not negative.

Henderson (HSBC):  We saw a strong "bear flattening" move as short-term rates rose, but the 10-year Treasury seems to have been holding below 2%. Investors have been differentiating among sectors that are facing challenges and those that are not. Setting aside strained sectors such as China property, investors remain constructive on higher-quality investment-grade names. There is good liquidity across the region. Investors are going to lean toward adding diversity to their portfolio.

Will investors look outside of China to add diversity? How is the rest of Asia different from China?

Agarwal (DB):  The rest of Asia is basically different from China in its composition. For example, Indian speculative grade is a US$35 billion to US$40 billion market. Renewables make up about 30% of that figure, about a third are metals and mining firms and 10%-15% are nonbank financial companies.

Last year, commodities did very well and renewables were stable. Similarly, in Indonesia, coal and oil firms account for around 40% of the market--both commodities had a good year.

Chia (Schroders):  One of the best bottom-up indicators is the maturity profile. This year, the volume of South and Southeast Asian (SSEA) bonds maturing by value is not significant. The bulk of the maturities are from 2023 and 2024 onward. In terms of imminent refinancing risk, it's a walk in the park compared with what you see in China property.

How do fundamentals look outside of China? Will they improve or worsen this year?

Gopalakrishnan (S&PGR):   Many issuers deleveraged last year, and we think this will continue. Many Indian companies will continue to generate positive free cash flows, as their capex is not high. We forecast their EBITDA this year will be about 40% higher than in 2018 and 2019, which indicates the potential for free cash flow generation. Commodities firms' above-normal profits drive a lot of this. Even if you leave out commodities, we think operating conditions are favorable.

Many issuers are committed to reducing debt. This was demonstrated last year when firms across sectors raised equity (e.g. telecom, pharmaceuticals, and steel) or monetized assets (e.g. electric-vehicle businesses owned by carmakers).

Chia (Schroders):  There is divergence among sectors. The Philippine consumer and property sectors are turning around. Indonesian property is finally picking up after a long haul. Compare this with Macao gaming and SSEA airlines, which have been taking three steps forward and two steps back, and are still far from a full recovery.

Agarwal (DB):  Last year was good for SSEA companies. Default rates were very low outside China. There weren't any in India and just a few in Indonesia. The banking system was flush with liquidity. Deutsche Bank estimates that the Indian banking system had about Indian rupee 9 trillion of excess liquidity last year. At its peak, the Indonesia banking system had excess liquidity of about 90 trillion Indonesian rupiah.

This meant that many companies were able to borrow. Even dollar liquidity was accessible in markets such as Indonesia, which is typically short on dollars. We had quite a few issuers that tapped the bank loan market for U.S. dollars to refinance their dollar bonds.

Will inflation create cost pressures and drive up credit risks in Asia?

Agarwal (DB):  Inflation is not a big risk for all sectors. For example, commodity players may benefit from higher prices. We are already seeing that with oil and some of the other commodities. Other key sectors such as renewables have built-in mechanisms that allow them to pass through some costs.

Chia (Schroders):  Cost pressures are usually not felt immediately. There's always a lead and lag time. Some sectors, such as tire manufacturers, have a three to six-month lag before higher oil prices increase rubber costs and hit margins.

Gopalakrishnan (S&PGR):  Favorable demand conditions are working in companies' favor. We are seeing this in most sectors, but commodities and autos in particular.

Issuers in low-margin sectors face more difficulty, especially those that rely on a handful of large clients. Auto parts is one example. It's not easy to raise prices on large carmakers. Pharmaceuticals, where some issuers face price controls, and where raw materials make up 45% to 50% of costs, also come to mind. Lastly, IT service firms also cannot easily pass on cost increases to customers.

Will accelerated U.S. rate hikes weigh on Asian issuers?

Agarwal (DB):  Rates will start going up across Asia this year, as most countries are likely to go along with the U.S. Federal Reserve. Liquidity in domestic markets has likely peaked.

Gopalakrishnan (S&PGR):  Abundant liquidity still exists in Asia even though rates are going up. I don't think this liquidity will go away in a hurry even as rates rise. As long as the Fed communicates the pace of its rate hikes clearly, markets adjust to that, and volatility is contained, it should still be a supportive environment.

Chia (Schroders):  Rate hikes affect how Asian currencies move. When you have currency volatility, that swing is felt much more than cost pressures from inflation, because it is felt immediately. Even if you are fully hedged, currency volatility may cause bond yields to spike.

What are some downside risks to the consensus view that Asia will do better because it is delinked from China?

Agarwal (DB):  Everybody has the consensus view that default rates will stay low in the rest of Asia this year. Indeed, it is difficult to come up with many names outside China speculative grade that could default this year. We may see just one or two surprise defaults from Indonesia.

That said, I am not convinced credit quality will improve in SSEA this year. It may get worse, partly because funding costs are only getting higher. While some companies want to cut debt, there are others getting more aggressive with their capex plans, for example, in the Indian steel sector.

Gopalakrishnan (S&PGR):  Some companies will find it difficult to raise debt, such as a few 'B' rated entities with steep debt maturities. Investors will need to watch out for those situations.

Will there be a risk of contagion from China to the rest of Asia?

Agarwal (DB):  The connection is in fund flows. We could start seeing major outflows from speculative-grade funds, Asian credit funds or even global fixed-income funds. If some of these funds are forced to sell Indian and Indonesian corporate bonds to meet their redemptions, SSEA speculative grade could come under strain, alongside China.

Chia (Schroders):  There is always an impact. For most of last year, China nonproperty and other parts of the market remained resilient. But in mid-January, we suddenly saw a huge crack in Indian speculative-grade debt. This implies that, fund flows aside, in a down market, the sectors that held on well cannot hold on forever. There will be a time when investors may want to lock in gains for sectors that have outperformed.

With credit quality stabilizing or improving, is the worst over for Asia ex-China?

Lemos-Stein (S&PGR):  It's important to note that last year wasn't exactly a reversal. There were far fewer entities being upgraded in 2021 than the overwhelming number of downgrades in 2020. Ratings are still lower than they were prior to the pandemic. We still have a high degree of fragility as we have so many ratings in the 'B' and 'CCC' categories--globally and in Asia.

Writing: Jasper Moiseiwitsch

Related Research

• Asia-Pacific Credit Outlook 2022, Feb. 14, 2022
• Indonesia's Ban On Coal Exports Highlights Regulatory Risks, Jan. 24, 2021
• SLIDES: Downside Risks Remains High For Thailand, Oct. 21, 2021
• SLIDES: Downside Risks Remain For Indonesian Credit Despite Recovery, June 8, 2021
• Indonesia Developers: Stronger Sales Won't Fix Everything, May 20, 2021
• Corporate Credit Recovery In Southeast Asia Lacks One Key Ingredient: Liquidity, April 13, 2021