Co-written by Roselle B. Dime
While Asian economies increasingly rely on local currency debt for long-term financing, the interest rates Asian governments pay on such debt varied widely during 2000-2015, as we can see in the theme chapter of the June 2016 Asia Bond Monitor (ABM). US yields trended down since the 2008–2009 global financial crisis and remained below pre-crisis levels amid uncertain growth prospects. While Asian countries share at least some correlation between their government bond yields and US Treasury bond yields, we also observe significant differences across the region.
Bond yields in the Republic of Korea, the Philippines, and Singapore have trended down since the global financial crisis, in tandem with US bond yields. The premium vis-à-vis US yields also fell for both Korea and the Philippines. In Singapore, bond yields were below those of the US in most years during 2000–2014. Indonesian bond yields and premiums declined after peaking during the global crisis. Indian, Malaysian and Thai bond yields were broadly stable, and showed no clear overall pattern. The different movements in yields across the region indicate economy-specific macroeconomic conditions that affect yield patterns.
Bond yields across the region are driven by both domestic fundamentals and global factors. Since bond markets are an increasingly important source of financing in Asia, it is worthwhile to examine the major determinants of bond yields and bond market development. The literature suggests that inflation, short-term interest rate, economic growth, fiscal health, and other domestic factors, as well as global factors, affect domestic bond yields.
Understanding the determinants of bond yields is of more than passing interest. Better understanding of the factors that affect the cost of borrowing can help economies manage such factors more effectively. Furthermore, better understanding of the impact of global factors—which are beyond the control of emerging economies—can help those economies prepare for and adjust to global shocks.
Using quarterly data from Q1 2000 to Q4 2015 from nine major emerging Asian economies, the latest ABM empirically analyzed the determinants of bond yields. The nine economies—selected on the basis of data availability—are India, Indonesia, the Republic of Korea, Malaysia, Pakistan, the Philippines, Singapore, Sri Lanka, and Thailand. The analysis seeks to explain the yields of 5-year government bonds with four domestic variables (inflation, short-term interest rate, GDP growth, and government debt growth) and one external variable, 5-year US Treasury bond yield, which captures global liquidity conditions.
The analysis considers both consumer price index (CPI) inflation, which is relevant for households, and producer price index (PPI) inflation, which is relevant for businesses. The vast majority of existing studies on bond yields only look at one price index, usually the CPI, so this is an innovative contribution of the ABM analysis to the literature. Producer and consumer price indices embody different baskets of goods and services, so a priori there is no reason for them to have the same effect on bond yields. More generally, there are sometimes substantial differences between the two. For example, a number of major Asian countries experienced producer price deflation in 2015, including even high-inflation India, as a result of weak commodity prices and growth slowdown. But even in countries where PPI inflation fell, overall CPI inflation remained positive, albeit subdued.
CPI and PPI inflation rates, selected Asian countries. Source: Eichengreen, Park, and Shin, “Deflation in Asia: Should the Dangers be Dismissed”, a forthcoming ADB working paper.
Our empirical evidence for the nine Asian economies as a whole indicates that both CPI and PPI inflation have a direct effect on bond yields. The significant, positive effect of inflation on yields is consistent with the existing literature and intuitively plausible. Higher inflation erodes real returns and therefore can push yields up. When we examine the data for each country, CPI inflation seems to matter more for bond yields in some Asian countries, while PPI inflation seems to matter more in other countries. For example, CPI inflation has a bigger effect on bond yields in Malaysia and Thailand while PPI inflation is more influential in India and Korea. Therefore, monetary and other government policies that affect inflation and hence bond yields will be felt primarily through the CPI inflation channel in some countries, but through the PPI channel in other countries.
Besides CPI and PPI inflation, the other primary direct drivers of Asian bond yields are short-term interest rates and US Treasury yields. Output growth and government debt growth also affect yields, but indirectly through inflation. The results are in line with previous studies. At a broader level, our evidence re-confirms the central importance of low inflation and macroeconomic stability in the development of local currency bond markets.
Roselle B. Dime is a consultant with ADB’s Economic Research and Regional Cooperation Department.