"While the Brexit vote created uncertainty and volatility, especially in the developed markets in the immediate aftermath of the vote, the markets in East Asia have largely regained calm, said Shang-Jin Wei, ADB's Chief Economist. "ADB research suggests that countries with capital flow management measures or a flexible nominal exchange rate regime are likely to be better prepared to eal with the risk associated with a future US interest rate increase, especially if they have adequate foreign exchange reserve as a cushion, which characterizes most countries in the region."
The report notes that yields for 2-year and 10-year local currency government bonds in emerging East Asia were mostly lower between 1 June and 15 August and stock markets in the region recorded gains as well, giving investor sentiment a lift. Over the same period, most East Asian currencies also appreciated against the US dollar, with the Korean won recording the biggest gain of 7.7%. The exception was the Chinese renminbi, which fell 0.9% during the period.
Emerging East Asia's outstanding local currency bonds were up 6% quarter-on-quarter and nearly 22% year-on-year, reaching $10 trillion. Local currency bond issuance in the second quarter totaled $1.3 trillion, recording double-digit growth both on a quarterly and year-on-year basis. Bond issuance was led by the People's Republic of China which remains the largest local currency bond market in the region with outstanding bonds of $6.9 trillion at the end of June.
Moving forward, the report notes that while markets are calm, there are rising risks to East Asian bond markets. A hike of the interest rate by the US Federal Reserve could prompt foreign investors to cut their holdings of East Asian local currency bonds. Negative interest rates in markets such as the European Union and Japan, could increase capital inflows to emerging markets, jeopardizing financial stability in Asian markets. The report cautions that increased capital inflows could lead to currency appreciation, which would undercut economies heavily reliant on exports and contribute to deflationary pressures.
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