- China's reopening and a potential Fed pause are the key pivots that have driven optimism in Asia's credit markets.
- Yet a reviving China could push up global inflation, compel "higher for longer" rates, and exacerbate recession risks in the West.
- These are among the conflicts and contradictions that panelists debated at our annual Asia corporate credit conference.
Asian credit markets started 2023 with a bang on great expectations behind two major policy pivots: China's reopening and the U.S. Federal Reserve's slowing rate hikes. However, the initial exuberance in U.S.-dollar bond issuance is cooling as the pivots' inherent contradictions drive disagreements on their implications for investors in 2023.
These shifts promise to reverse the two factors that made 2022 one of the worst years in Asia credit history. However, they also raise risks of over-confidence and "higher for longer" rates. These questions permeated lively panel discussions at a recent S&P Global Ratings conference on the outlook for Asian corporates in 2023.
"How much confidence should we have in these pivots?" asked Charles Chang, the Greater China Country Lead for Corporates at S&P Global Ratings. "Will they support markets throughout this year? Or will they be riddled with setbacks and contradictions that drive volatility and downside risks?"
Other key questions include:
- Does the Fed pivot call for optimism or caution?
- Will China's reopening drive up global inflation?
- Which Asian countries will gain and lose?
- How will investors balance risk and reward ahead?
- Will China and Asia see an issuance boom this year?
- What could lead to less issuance?
- Where are the bright spots and the storm fronts?
- Will Asian perps be called under "higher for longer"?
|Panelists At Our 2023 Asia Corporate Credit Outlook Conference|
|Panel: The Year Of The Pivots|
|Moderator||Industry panelists||S&P Global panelists|
|Charles Chang, China Country Lead, Corporates, S&P Global Ratings||Neeraj Seth, CIO and Head of Asia Credit, BlackRock||Gregg Lemos-Stein, Managing Director and Chief Analytical Officer, Corporate Ratings, S&P Global Ratings|
|Gordon Tsui, Head of Fixed Income, PingAn of China Asset Management (Hong Kong) Ltd.|
|Janessa Jia, Head of Fixed Income, International Team, Investment Banking, China International Capital Corp.|
|Panel: Commodities--Higher For Longer?|
|Moderator||Industry panelists||S&P Global panelists|
|Richard Timbs, Senior Director, Pacific Country Lead, Corporate & Infrastructure Ratings, S&P Global Ratings||Soo Chong Lim, Managing Director and Head of Asia Credit Research, J.P. Morgan||Kang Wu, Head of Global Demand and Asia Analytics, S&P Global Commodities Insights|
|Thu Ha Chow, Head of Fixed Income Asia, Robeco|
|Source: S&P Global Ratings.|
Does The Fed Pivot Call For Optimism Or Caution?
The Fed's pivot on rate hikes led to a strong start to Asia's primary and secondary bond markets this year, particularly for investment-grade issuance. However, markets are cooling as stark differences in views arise.
Gordon Tsui of PingAn sounded a positive note: "Markets expect only two more 25 basis point hikes this cycle. It's a very benign environment for fixed-income, and investors may take this opportunity to lock-in higher overall yield."
Neeraj Seth of BlackRock cautioned: "It's premature to start pricing in cuts when we have not even gotten to a pause." He noted that the Fed has been very clear that it wants to see inflation close to the targeted 2%, and it will pause but stay restrictive until this happens.
"The markets tried to front-run the Fed, but it's an unknown if we will get to the Fed's target in six to nine months," said Mr. Seth. On the recent run-up, he noted the start of the year was more constructive for credit, but some opportunities may have narrowed.
Will China's Reopening Drive Up Global Inflation?
Panelists generally agree that China will not backtrack on its COVID loosening, which will be "one direction of travel from here," said Mr. Seth (BlackRock). This, plus supportive regulatory shifts in real estate and other sectors, will provide a positive backdrop. That said, he warned, "this will also bring inflationary impulses domestically and internationally."
Gregg Lemos-Stein of S&P Global Ratings described China's reopening as a "double-edged sword," pointing out that "benefits of supply chain easing could help tame inflation, but the amount of demand that could come online could exacerbate the commodity situation."
Thu Ha Chow of Robeco took a different angle. She points out that China today is different from China of the past, in the sense that it is now focused on healthier, less rapid growth. Ms. Chow also noted that the government refrained from large fiscal handouts, hence, consumers may be less aggressive in exit spending. Lastly, she noted the slack in China's labor market and recessionary forces in the West will help mitigate inflationary pressures and provide a more balanced exit.
Kang Wu of S&P Global Commodities Insights has a similar view, noting "China is only part of the whole picture." He expects the country's increased appetite for commodities to be tempered by relatively weak demand elsewhere, leading average oil prices to be lower this year than last year.
Which Asian Countries Will Gain And Lose?
Although most panelists expect Asia to benefit from China's reopening, they cautioned that some countries may face some downside risks.
Soo Chong Lim of J.P. Morgan said: "If China is going to grow at a faster pace, that's obviously going to be very positive for the region as a whole."
Ms. Chow (Robeco) added that the recessionary drag from the West and the more recent exits from COVID restriction of most of Asian countries could be "quite a nice combination of effects," as it provides the region more space to benefit from reopening tailwinds without stoking inflation.
On countries, Mr. Seth (BlackRock) cautioned that inflationary impulses may be carried through oil prices and affect oil-importing countries. "This will reduce the room to ease for central banks in India or other South Asian countries, a situation which is obviously negative."
Indonesia, on the other hand, "should be in good shape," said Mr. Lim, since it is a net exporter of commodities and will benefit if China's reopening drives up prices. This, and the government's recent focus on financial stability, are things that investors like, he added.
Mr. Seth shares this view, noting that effects on Southeast Asia will be on the positive side through trade channels. Indonesia, Vietnam, Taiwan, or even South Korea in North Asia, will also see positive benefits for this reason, he added.
How Will Investors Balance Risk And Reward Ahead?
The panelists agree that volatility will continue, but that the growth and rates backdrop looks more benign.
Mr. Seth (BlackRock) expects a "somewhat volatile environment over the next 12 months" and that investors may stay cautious, or "closer to home," after the recent run-up. "Those policies that shift China to a positive backdrop do give you reasons for markets being where they are," he noted, "but it's more complex under the hood. You still have to look through the sectors, you still have default risks." At this point, "it makes sense to be more balanced than to have a very strong preference," he added.
Ms. Chow (Robeco) is of a similar view, noting "markets may remain elevated, and they will be volatile, so it's going to be difficult to navigate." She noted that it's still unclear what kind of recovery will unfold in China--whether it will be driven by consumption or by real estate, which will have different implications for commodities and global demand.
Mr. Tsui (PingAn) took a different view. He noted that "deploying funds as efficiently as possible" is still the focus for many investors, including those that focus on investment grade. They may also consider the lower end of the ratings spectrum given the more benign backdrop.
Will China And Asia See An Issuance Boom This Year?
Janessa Jia of CICC is "cautiously optimistic" on China. Asia G3 issuance totaled US$33 billion in the first two weeks of this year, up from US$25 billion last year. "But China made up only 16% of this, versus roughly half in the last two years," she noted.
Ms. Jia expects more issuance could be driven by positive sentiment, narrowing spread between U.S. and China's domestic rates, and about US$115 billion of Chinese offshore bonds maturing in 2023, which is large compared with last year.
"The reopening means Chinese issuers will now be able to come to offshore markets to do roadshows," she added. She expects issuance from China to gradually come back in 2023, with financial institutions taking the lead, followed by high-grade corporates or state-owned enterprises (SOEs).
As for the rest of the region, she noted that although volatility may persist, issuance may pick up from Korea, Indonesia, Singapore and Hong Kong, adding "issuers will try to diversify their yield curves a bit more, and issue longer tenor where the cost of funding is lower."
Rates And Credit Risks Shut Asian Markets In 2022
What Could Lead To Less Issuance?
Despite the great expectations of an issuance boom from Asia, the panelists raise one key factor that could stand in the way: more competitive domestic markets, where rates are lower and liquidity is stronger.
"This is not just in China," said Mr. Tsui (PingAn), "in Indonesia, India, Thailand, and other Asian countries, domestic funding rates are cheaper than U.S. dollar funding rates for corporates, because their central banks have been more reserved in hiking rates." He noted that as more CFOs ask: "Why not just fund in the domestic market?", we may see less issuance in the dollar space.
Ms. Jia (CICC) agreed, "the spread between U.S. dollar and China onshore funding costs is still quite large, so many issuers will be monitoring the market to find a better window throughout the year rather than rush in."
She noted that offshore net issuance from China, or new issues minus maturities, was roughly negative US$100 billion in 2022, which left only US$780 billion outstanding.
Will Asia Become A 'Pain Trade'?
The imbalance between the supply and demand of Asian bonds may raise risks for investors, the panelists pointed out under varying expectations.
Mr. Seth noted that a lot of global investors became very cautious on Asia and reduced their exposure last year; and they may not have come back yet. A key challenge, he said, is that the supply of higher credit-quality bonds from China remains limited and "the issuance coming out is very different from the pockets where they would like to readjust their exposures."
Mr. Tsui (PingAn) took a different perspective, noting that the "Great China Reopening" went from a rare view in November to a consensus view in January, but it may become a "pain trade" if global investors do not manage to replenish their Chinese bond holdings. If they cannot do this through new issues, they may just have to "chase markets in a vacuum," he said, which could lead Asia to outperform Europe or the U.S. this year.
Mr. Lemos-Stein (S&PGR) noted that in the U.S., "there is more interest in Asia, given the reopening and the pivot, but there's a lot of caution, and most are taking a wait-and-see attitude." That said, he notes international investors may increasingly turn to Asia, as "Europe is problematic, and emerging markets have their own challenges."
Mr. Seth (BlackRock) echoed this point: "There have been significant outflows from Asia over the last 18 months, but as China reopened and the Fed slowed down on hikes, some of that started to trickle back in". He expects fund flows to remain positive for Asia over the next six to 12 months, although not in very large volumes.
This includes Asia's local bond markets, which saw outflows over 2022 but may benefit as Asian currencies stabilize against the dollar, he said. "We are starting to see early signs of a shift under a combination of active decisions as well as the index inclusion that's coming through," he noted.
Where Are The Bright Spots?
For investment grade, Mr. Seth (BlackRock) has positive outlooks on India, Indonesia and China, and outside Asia, on the Middle East. For speculative grade, he is cautiously optimistic on certain pockets of India and on higher-quality China real estate, with the caveat that "although some liquidity support is coming to the sector, it is very important to see improvements in the fundamentals in terms of home sales, housing starts, land sales etc."
Positive Outlooks Are Driving Bounceback Across Asian Markets
Mr. Tsui (PingAn) sees Asia's economic fundamentals as stronger than other regions. For example, he expects Macau's recovery to be "quite sharp," which makes casino operators there stand out versus comparable names in other countries.
On China real estate, he expects offshore bonds to benefit as more developers issue onshore with guarantees by the government-backed China Bond Insurance Co. Ltd. (CBI). Offshore rates are still "quite painful," he said, when comparing CBI-backed bonds' single-digit coupons against the 11% on the latest offshore property bond issued by Dalian Wanda Commercial Management Group Co. Ltd.
Views on China's local government finance vehicles (LGFVs) are more nuanced. Mr. Seth noted that it's difficult to "paint the whole sector with the same brush" and that one needs to look name by name and be selective in this space based on a framework around the overall profile and the strategic importance of the LGFV from the province's perspective. "It's certainly an important sector. A number of them will play an important role in the reopening and the acceleration in fixed asset investment."
Where Are The Storm Fronts?
The positivity in Asia contrasts with outlook on developed markets outside the region. Mr. Lemos-Stein (S&PGR) warned: "There's no easy way out. It's going to be very dicey and very much a balancing act for us to avoid credit turmoil in 2023. It leaves little room for error for the central banks."
"We expect gas and power prices and markets to be very expensive and very volatile in Europe for the next year or two." He noted that the region dodged a very difficult situation with a mild winter, but that situation is not going away. "Consumers in many European countries are going to be paying 5x-10x the price for gas as in the U.S. and Asia, which will also affect energy-intensive industries."
Credit pressures are also intensifying in the U.S. and elsewhere: "Leverage has been creeping higher over a few decades on low rates, and a lot more debt was piled on during the pandemic. As borrowing costs rise, this puts the weakest borrowers in a precarious position," said Mr. Lemos-Stein.
Investment-grade entities tend to be less volatile in tougher financial conditions. For example, although 'BBB' borrowing costs rose from 2.5%-3% at end-2021 to roughly 5% now, many issuers have strong enough free operating cash flows and interest coverage to withstand that. "A lot of them also have longer-dated, fixed-rate debt, so they don't have to go to the market for a much longer period of time."
However, Mr. Lemos-Stein points out that some 'B' rated firms may not have sufficient cash flows to absorb their borrowing costs suddenly doubling from 5% to close to 10%. "They have to show enough organic cash flows by battening down the hatches, cutting discretionary capex etc., but many of them haven't," he said, adding "gone are the days where they can just keep borrowing and run at cash flow deficit."
Global Borrowing Costs Are Still Elevated
Can they find alternative funding sources? Mr. Lemos-Stein noted "there aren't a lot of options for firms that are essentially close to being insolvent". He noted that the booming private credit market is not necessarily a source for very distressed firms, and collateralized loan obligation (CLO) managers can only hold a limited amount of 'CCC-' rated debt. "They still have some room, but those buckets are filling up, so that avenue is closed for the time being."
To Call or Not To Call? – Asian Perps Under "Higher for Longer"
The instruments that are front and center in investors' minds amidst rising rates are hybrids and perps," Mr. Chang (S&PGR) noted, and asked: "will we see more issuers not calling because of higher rates or calling because they want to avoid disruptive episodes like those in Korea and China recently?".
Janessa Jia (CICC): In China, non-call risk is relatively low because onshore rates are low and the issuers are mainly banks and SOEs that can access funding both onshore and offshore. They may need to pay 5% offshore now but only 3% onshore for a five-year bond. Also, the incentive to issue more perps has been reduced by the Ministry of Finance's rule change that no longer allows corporates to treat perps as equity. Firms that used to issue perps to avoid breaching regulatory red lines may shift to issuing senior bonds, unless perps offer very long term and real cost advantages.
Gordon Tsui (PingAn): For China's callable perps, the step-up coupon may be a key determinant of non-call risk. If it is high enough, it should provide an incentive to call. That said, economics is not the only factor. Korea's Heungkuk Life is an example of a non-call that was perhaps based on economics initially. The decision was later reversed, but the damage has been done. Investors are still worried about that, but the most they can do is assess whether the step-up is good enough.
Gregg Lemos-Stein (S&PGR): From a credit perspective, the important thing is that the hybrid remains in the capital structure in good times and bad – like a bond in good times, and like equity in bad times. What allows us to give 50% equity credit in our ratios is our confidence that the firm is committed to the hybrid as permanent, or long-term capital that can help absorb losses and support credit quality when needed. Given this, not calling is fine, calling and replacing is fine, but calling and not replacing is problematic, since the hybrid is no longer there, and we gave equity content on the understanding that it would be there through good times and bad.
- Asia-Pacific In 2023: China Rebound Cannot Offset Western Slowdown, Feb. 23, 2023
- Asia-Pacific Credit Outlook 2023: Sand In The Gearbox, Feb. 21, 2023
- Which Emerging Markets Benefit The Most From A Reopening In China?, Feb. 2, 2023
- Macao Gaming: Brighter Prospects For Revenue Recovery, Jan. 17, 2023
- China Property Is On The Cusp Of A Recovery, Jan. 12, 2023
- Rising Offshore Exposures Pile On Risks For China's LGFVs, Jan. 10, 2023
- Asia-Pacific Corporate Hybrid Capital: Equity-like Features Come Into Focus Amid Market Turbulence, Dec. 13, 2022
- Global Credit Outlook 2023: No Easy Way Out, Dec. 1, 2022
- S&P Global Ratings Revises Its Oil And Gas Price Assumptions On Supply/Demand Fundamentals, Nov. 19, 2022
- S&P Global Ratings' Metal Price Assumptions: Lower Prices And Higher Costs Start Squeezing Profits, Nov. 1, 2022
This report does not constitute a rating action.
|China Country Lead, Corporates:||Charles Chang, Hong Kong (852) 2533-3543;|
|Secondary Contacts:||Christopher Lee, Hong Kong + 852 2533 3562;|
|Gregg Lemos-Stein, CFA, New York + 212438 1809;|
No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.