The Empirical Evidence on Government Bond Market Integration in East Asia

Abstract

I. INTRODUCTIONSince the 1997 Asian financial crisis, bond market development has been the central pillar of financial cooperation in East Asia. Many scholars argue that while individual countries strive to develop the domestic bond markets, it is also necessary to build a regional bond market, where governments, corporates or other institutions can finance themselves through the regional capital pool in a minimum cost (Shimizu, 2007; Rhee, 2003). From the perspective of investors, bond market integration enables them to diversify the country-specific risks through holding a wide range of bonds both inside and outside the country in a very low cost. (Baele et al., 2004). From the perspective of bond issuers, entrepreneurs with little initial capital or facing credit constraint in small economies can turn to broader capital markets, which implies a strong correlation between the bond market integration and economic growth (Levine, 1997). Less dependency on the long- term borrowing from overseas banks offers East Asia the potential to migrate the double mismatch problem and enhances the region's resilience to negative external shocks.To this end, a number of initiatives have been pursued to promote the regional bond market development in East Asia. Asian Bond Markets Initiative (ABMI) in 2003 is the milestone for the regional governments' cooperation to develop the regional bond market. In the following years, ASEAN+3 economies have continued to move forward through upgrading arrangements, harmonizing institutions and regulations within the region to promote the regional bond market integration. For example, Credit Guarantee and Investment Facility (CGIF) was launched, under the framework of ABMI, to facilitate East Asian corporations to issue local currency denominated bonds by providing credit enhancement in 2010.Asian Bond Fund is another major initiative to promote regional bond market development. The Executive Meetings of East Asia and Pacific Central Banks (EMEAP) launched the ABF 1 with a capitalization of USD 1 billion in 2003. However, due to its small size, ABF 1 had little effect on the market for dollar-denominated government bonds in East Asia. Later, ABF 2, introduced in 2004 with a capital of USD 2 billion, was implemented to purchase local currency bonds from Asian countries. One of their aims is to increase the demand for the regional bonds by investing in a large pool of US dollar denominated government bonds issued by local governments or organizations in eight EMEAP economies, namely, China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand.Furthermore, because the bond markets in East Asian economies are relatively independent due to different regulations and currencies, to build a regional bond market, East Asian countries try to harmonize bond standards and practices at the national levels to encourage more intra-regional issuance and transaction. As a result, ASEAN+3 Bond Market Forum (ABMF) was established under the framework of ABMI to harmonize the market regulations concerning cross-border transactions in September 2010. The ABMF is constituted of two sub-forums. Sub-Forum 1 (SF1) collects and compares bond market regulations in East Asia, in the meanwhile, Sub-Forum 2 (SF2) tries to standardize regional transaction procedures and harmonize market regulations.Despite the numerous benefits bond market integration may bring to East Asia, the potential risks should not be ignored, such as the financial contagion. The financial instability in one country can be transmitted to the neighboring countries quickly. For example, the Asian financial crisis in November 1997 started in Thailand with the collapse of the Thai baht and rapidly swept over Indonesia, Malaysia, Korea and beyond, generating serious impact on the world economy as a whole. Another example is the outbreak of the European debt crisis, which also reveals the potential risks from the financial integration in the Eurozone. …