Emerging economies must grow their domestic investor base to complement foreign cash flows to local bond markets, a move that will also shield them from bouts of global risk aversion, a top fund manager said on Tuesday.
A six-week long sell-off has hit emerging market stocks, bonds and currencies as rising global interest rates have started to choke off the flow of cheap investment money that poured into higher-yielding assets in recent years.
Robert Parker, vice chairman of Credit Suisse Asset Management, which manages $474 billion in assets, said the setback underscores the importance of a domestic investor base for countries wishing to tap local bond markets for finance.
"Over the next year or so it's inevitable that we see higher central bank rates so there is going to be a slow tightening of global liquidity," Parker said. "In this environment the key to successful development of local bond markets willernments of developing countries are increasingly shifting their borrowing needs to bonds denominated in local currencies instead of the more traditional dollar-denominated debt markets in order to cut currency risks.
While investors hunting for high yields have poured into local currency bonds in recent years these markets are still seen as volatile and less developed. In many countries, especially those with current account surpluses and fewer funding needs local bond markets are still small.
Parker said Asia is where governments can use better use local bond markets to harness the region's high savings rates by developing the local mutual fund industry.
The US mutual fund market is worth $7 trillion, he said, comparing it with China where it totals just $70 billion. South Korea is a good role model for Asia, with about 20 percent of local savings mobilised into mutual funds, compared to China's 5 percent, Parker noted.
"That's very small compared with China's savings ratio of 40 percent (of gross domestic product) or so," he told conference delegates, but noted that government incentives could help this market blossom in the next five years to nearly $1 trillion in assets. In another large emerging market, Russia, Parker estimated the mutual fund market at under $5 billion.
"Over 60 percent of Russian domestic savings are deposited with the largest bank, Sberbank. The challenge is to move this money from the banking system into mutual funds," he said.
There is evidence local investors are slowly moving to the mutual fund market in Asia, Parker said, citing a successful Credit Suisse joint venture that launched in China last autumn. The venture, targeting Chinese investors, raised an initial $600 million, then an extra $1.2 billion in yuan equivalent.
Developing local bond markets has long been discussed by Asian countries which are growing more keen to use their massive foreign exchange reserves within the region, instead of investing them in US Treasuries.
"One theme among reserve-rich central banks is clearly increased diversification," Parker said. "China won't dump $900 billion of Treasuries but the overall trend is development of local markets so America can't continue to rely on global savings to finance its current account deficit."