1. Introduction

Emerging East Asia witnessed rapid and remarkable economic growth over the past few decades. It has been the fastest growing region in the world. In this study, emerging East Asian economies include nine countries, Hong Kong, China, Indonesia, People Republic of Korea(Korea), Malaysia, People's Republic of China (PRC), Philippines, Singapore, Thailand, and Viet Nam. Table 1 presents the spectacular economic growth of the above economies during 2003-2007 in terms of year-to-year Gross Domestic Product (GDP) growth. PRC exhibits the highest economic growth throughout the period followed by Viet Nam. Last year, the growth rate of these counties varied from 5.0% in Korea to 11.4% in PRC.

However, all these economies, with the exception of PRC, and Viet Nam, have witnessed a severe financial crisis during 1997-1998.

One of the reasons behind the Asian financial crisis in 1997 was the excessive dependence of the Asian economies on commercial banks for domestic financing. The major sources of corporate financing were banks because another source of financing, namely the bond markets were underdeveloped and their sizes were quite small. Another reason behind the crisis was the “double mismatch” problem or the “twin risk” problem, namely currency and maturity risks. Corporate borrowers predominantly created this problem by raising funds in foreign currency and on a short-term basisTheEast Asian corporate sector borrowed short term from commercial banks in foreign currency for long-term domestic investment. Corporate firms and banks faced payment problems when outflow of capital from the region caused severe currency depreciation and their debt in terms of the local currency rose significantly. The financial risk was more severe as the supervision of banks was inadequate and banks did not have good risk management capacity (Kawai, 2007, andADB, 2002).

Table1. Trends in Economic Growth (GDP growth) of Emerging East Asian Economies

Countries

2003

2004

2005

2006

2007

China, People's Republic of

10.0

10.1

10.4

11.1

11.4

Hong Kong, China

3.0

8.5

7.1

7.0

6.3

Korea, Rep. of

3.1

4.7

4.2

5.1

5.0

Indonesia

4.8

5.0

5.7

5.5

6.3

Malaysia

5.8

6.8

5.0

5.9

6.3

Philippines

4.9

6.4

4.9

5.4

7.3

Singapore

3.5

9.0

7.3

8.2

7.7

Thailand

7.1

6.3

4.5

5.1

4.8

Viet Nam

7.3

7.8

8.4

8.2

8.5

Source: Asian Development Outlook 2008, ADB

Looking at this situation a wider perspective, the Asian economy is still at a risk of a future crisis due to continued excessive reliance on bank lending. Since banks are highly leveraged institutions, the economy is much more vulnerable to a financial crisis than would be the case if more corporate borrowing had taken place in the bond market and the claims were held in well-diversified portfolios. Thus, the presence of such instability in the banking system can halt important investment projects and reduce aggregate demand (Herring, and Chatuspripiak, 2000).

In spite of spectacular economic growth, the size of bond markets of Asia's emerging economies is small compared to advanced economies and the level of their development is still low.

One approach to minimizing the risk of double mismatch is to develop sound and sustainable domestic local currency bond markets in East Asia. Developing stable and liquid bond markets will reduce the dependence of the corporate sector on banks and foreign currency financing. Through the local bond market, the corporate sector can borrow for longer maturity periods in local currency, which matches their investment needs and thus can avoid their balance sheet mismatches. In order to attract investment through issuing local bonds, Asian firms have to adopt international accounting practices, and enhance corporate governance, thereby becoming more transparent (Eichengreen and Luengnaruemitchai, 2004). According to Radelet et al (1998), a well developed, deep, flexible and highly volatile bond market could be a long term remedy for such a crisis.

Currently, Asia is once again facing another financial crisis as a consequence of the ongoing global financial crisis which originated in the United States. Due to the problem of a liquidity crunch, foreign banks are withdrawing dollar investments from Asia. As Asia still depends heavily on banks instead of bonds, the corporate sector in Asia including East Asia are facing severe constraints in securing foreign currency financing as well as local currency financing due to the lack of investors' confidence in the financial markets. At this juncture, it is very timely to enhance the development of bond markets in East Asia. For effective development of bond markets it is essential to identify the key determinants of bond markets or key factors affecting bond financing and magnitude of their relationship with bond financing.

The important question is what are major determinants of the size of bond financing of a country? A literature survey shows the following results.

It has been argued that the lack of the minimum efficient scale which is necessary for the development of a stable and large bond market is one of the key problems faced by small economies. Thus, multinational corporations and other foreign bond issuers may not be interested as the volume of capital that can be raised may be too insignificant (Eichengreen, Hausmann and Panizza, 2002). Therefore, the size of an economy measured by GDP (Gross domestic product) is a key determinant of bond financing size or bond market size.

Furthermore, some emerging Asian economies are still poor compared to advanced industrialized economies, even though they have witnessed high economic growth in recent years. These emerging economies lack institutions that can support financial markets. The unreliability of contract enforcement and uncertainty of investor rights present in these countries are obstacles to developing sound financial markets. Therefore, bond market development also significantly depends on the development stage of an economy (Eichengreen and Luengnaruemitchai, 2004). Therefore, the stage of the development of an economy as measured by per capita GDP is also one of the key factors affecting the size of bond financing.

When the economy is open, entrenched interests, such as banks that are usually reluctant to allow bond markets to encroach in their dominant market share, will be less effective in influencing polices that prevent competition from other sources of corporate financing (Rajan and Zingales, 2001). The openness of an economy measured by the size of exports compared to the size of the economy is another major determinant.

According to best of my knowledge, there are no empirical cross-section and time series studies concerning determinants of bond market size exclusively for Asian countries. This paper attempts to examine the trends in bond financing in East Asia and the relationship between types bond market sizes, such as total bond, government bond and corporate bond and their key three determinants through an econometric analysis. It covers 10 selected East Asian economies. namely Hong Kong; China(HK), Indonesia, People Republic of Korea(Korea), Malaysia, People's Republic of China (PRC), Philippines, Singapore, Thailand, Viet Nam; and Japan. The main reason for selecting these countries is the existence of bond markets and data availability. The Asian Bond Online website produces data on bond financing for the above countries only.

In particular, this study tests the following hypotheses for selected East Asian economies: Bond market size has a (i) positive relation with the economic size of an economy (measured by GDP); (ii) positive relation with openness of an economy (exports as proportion to GDP); and (iii) positive relation with the stage of development of an economy (per capita GDP).

2. Methodology

In order to make the data comparable across 10 countries, theBond financing size is measured by total, government and corporate bonds volume in percentage of each country's GDP. The economic size is measured by Gross Domestic Product (GDP). The openness of an economy is derived by total exports as proportion to GDP and the stage of development of an economy as per capita GDP in purchasing power parity (PPP) in US $ terms.

A methodology similar to Eichengreen and Luengnaruemitchai (2004) has been used in this paper. The paper uses simple as well as multivariate regression analysis based on time-series and cross section data for selected East Asian economies for the period 2000-2006. The times-series data of 10 Asian countries for 2000-2006 have been collected from respective governments' websites, ADB's website on Asian Bond Market and IMF website . The total number of data points should be 70. However, the actual data for regressions varied from 60 to 66 due missing data for some countries.

For examining the relationship and also testing above hypotheses, first a simple time-series regression analysis will be performed separately. Then multivariate regression models will be used for analyzing cross-section and time-series data in a single equation.The models are explained below.

2.1The Fixed Effects Model

A fixed effects model for cross-section time series data is a model where coefficients of independent variables do not change over countries. It is a linear regression model,

y = Xb + u, where

y =dependent variable

x = vector of independent variables

b= coefficients of independent variables, and

u = errors terms.

Assumptions of the model are:

A1: E(u|X) = 0 (the disturbances have conditional mean zero)

A:2 E(uu0|X) = variance =sigma=1 (conditional on the X, the disturbances are independent and identically distributed).

If A1 and A2 satisfied we can have BLU estimators. If A2 not satisfied, there could be problems of heteroscedasticity and serially correlated disturbances. Then it may be possible to implement a generalized least squares (GLS) estimator that is BLUE (at least asymptotically).GLS is a method that designed to deal with some common problems that occurs in time series cross sectional data.

In this study, first the following simple regression models are used:

Model 1: TFit= TBso1+ TBs1t X1it + TEsit1

Mode 2: TFit= TBso2 + TBs2tX2it + TEsit2

Model 3: TFit= TBso3 + TBs3tX3it + TEsit3

Model 2: GFit = GBso1+ GBs1t X1it + GEit1,

Model 4: GFit = GBso2 + GBs2tX2it + GEit2,

Model 5: GFit = GBso3+ GBs3tX3it + GEit3,

Model 6: CBit= CBso1+ CBs1t X1it + CEit1,

Model 7: CBit= CBso 2+ CBs2tX2it + CEit2,

Model 8 : CBit= CBso 3+ CBs3tX3it + CEit3,

Then, following three multiple regressions models are used:

Model 9; TFit= TBo+ TC t +TB1t X1it + TB2tX2it + TB3tX3it +TEit

Model 10: GFit = GBo+ GC t +GB1t X1it + GB2tX2it + GB3tX3it +GEit,

Model 11: CBit= CBo+ CC t + CB1t X1it + CB2tX2it + CB3tX3it +CEit, where

TFit = total bond market size in proportion to GDP of i country,

GFit = government bond market size in proportion to GDP of i country,

CFit = corporate bond market size in proportion to GDP of i country,

i= country, t = time,

X1i= GDP of i country;

X2i = exports as proportion to GDP of i country;

X3i = per capita GDP of i country, and

TEi, GEi, CEi = error terms

3. Trends in Bond Financing

Among ten selected economies, Japan is a developed country and the remaining nine countries are considered as emerging economies. With regards to Asia, bond markets continued to grow after the recovery from the financial crisis in 1997-1998. Total local currency bonds outstanding in emerging East Asia rose from $400 billion in 1997 to $2,840 billion in end-2006 (a seven-fold increase) or from 11.5% to 61.5% of emerging East Asia GDP. The share of local currency bonds also witnessed strong growth and accounted for 12% of the GDP in 1997 of the total financial system, and 19% in mid-2006. On the other hand, the share of bank financing decreased from 61% to 51% during the period. However, the size of the local-currency bond is still very small, only a very small proportion of total local currency bonds worldwide which amounts to more than $40 trillion. At the same time, market liquidity, measured by trading volume and turnover ratios, has increased in recent years, but it is still quite low compared to developed countries' markets. In particular, the liquidity for corporate bonds has been very limited. Except for Korea and Malaysia, governments have been major issuers of local currency bonds. In recent years, the shares of corporations and financial institutions as well as those of pension funds, life insurance companies, and mutual funds have been increasing. But their shares are still small. Thus, there is a need to further diversify the issuer and investor base (Chino, 2007).

Table 2 presents the trend and structure of bond market development during 2000-2006. The Table contains data on total bonds (TB), government bonds (GB), and corporate bonds (CB) market capitalizations as a percentage of GDP (used as dependent variables in the regressions), and Purchasing Power Parity (PPP) GDP (in US $ 2000 prices) and PPP per capita GDP (PGDP). In 2006, the share of corporate bonds is higher than that of government bonds in Hong Kong, China and South Korea whereas the ratios of those are very close in Malaysia and Singapore. For the rest of the economies, the share of corporate bonds is miniscule.

Emerging East Asia's bond market witnessed significant year-to-year growth during this period ranging except for Indonesia. However, government bond grew much faster ranging compared to corporate bonds except for Indonesia where corporate bond exhibited better growth. Government bonds constitute the major portion of total bonds issued and its role has continued to rise. Therefore, overall, corporate financing through bonds has not yet become popular and its role has been declining during 2000-06 for most countries except for Hong Kong, China, Philippines and Viet Nam. The corporate bonds have been playing an important role in Hong Kong, China; Korea and Malaysia with a share of over 50% in 2006. The share of bond in percentage of GDP varied widely over 10 countries ranging from 8% in Viet Nam to 166% in Japan. Indonesia and Hong Kong, China showed a decreasing trend in bond to GDP ratio as well as export to GDP ratio during 2000-2006.

Table 2. Structure in Bond Market Capitalization and Its Key Determinants:2000- 2006

Country

PPP GDP ( $ Billion)

PPP GDP per capita ($ 000)

Exports (% of nominal GDP)

Bond Market in Capitalization in % PPP GDP

Government

Corporations

Total

2000

2006

2000

2006

2000

2006

2000

2006

2000

2006

2000

2006

Japan

3246.57

35289.7

25624

27686

10.2

13.9

69.5

149.5

20.9

16.5

90.4

166.0

Indonesia

625

8032.0

2923

3465

39.6

34.6

35.4

18.8

1.4

1.8

36.8

20.60

South Korea

768.286

10077.4

16225

20631

33.6

37.9

-

51.4

-

53.7

-

105.1

Hong Kong, China

174

2197.2

26130

31660

13.9

12.1

8.2

8.9

27.6

41.8

35.8

50.7

Singapore

95.4

1211.8

23631

26977

90.0

111.9

27.1

39.5

21.3

30.7

48.3

70.2

Malaysia

205

2612.5

9407

10713

111.7

118.5

30.8

38.2

44

37.4

74.8

75.6

Philippines

305

3825.2

3825

4275

55.1

54.1

30.8

35.3

.

3.00

30.8

38.3

Thailand

386

5215.4

6240

8069

53.0

63.9

14.7

33.8

12.6

16.7

27.4

50.5

PRC

4960

82836.0

3909

6304

24.2

40.5

16.6

39.7

0.3

3.9

16.9

43.6

Viet Nam

158

2427.9

1998

2877

42.3

70.5

-

7.4

-

0.7

-

8.1

Source: Asian Bond Online, 2008, World Economic Outlook, 2007-2008, Note: PPP = Purchasing Power Parity in 2000 prices

4. Empirical Results

This section will present the results of eleven simple regressions and multiple regressions analysis as well as scatter plots to establish the relationships between types of bond market size and their determinants.

4.1 Results of Simple Regression Analysis

4.1.1 Relationship between Types of bonds and the Country Size

Figures 1, 2 and 3 show scatter plots on the relationship between bond financing size and size of economies. Figures 1, and 2 are consistent with the notion that size of an economy and its bond market size is positively associated. But the figure 3 shows a negative relation.

Table 3 below presents the simple regression results on the relationship between bond financing size and size of an economy. The table 3; and graph 1, 2 and 3 show that a relationship exists between each type of bond market and country size. However, the sign of slope coefficients are negative for regression equations for corporate and government bond which is contrary to the expectation. The t-statistics are significant at the 15% level for government and for rest they are significant at 5% level. Among the three bond markets, government bond has the highest r-square value at 0.22. This means that 22% of the variance in the dependent variable can be explained by the regression equation.

Table 3. Relation between Types of Bonds and Country Size

Model

Total Bond

Government Bond

Corporate Bond

In GDP (bill US$)

Intercept

Slope

Intercept

Slope

Intercept

Slope

Coefficient

-0.333

0.065**

-1.035***

0.104***

0.701***

-0.039**

Standard error

0.439

0.033

0.313

0.023

0.230

0.0173

t-stat

-0.759

1.968

-3.304

4.401

3.048

-2.236

p-value

0.4500

0.053

0.001

3.89E-05

0.0032

0.0286

R Square

0.0539

0.221

0.068

Note: Significance tests: *** means significance at 1% level: p<0.01, ** means significance at 5% level: p<0.05, and * significance at 10% level p<0.1

4.1.1 Relationship between Types of bonds and Stage of Economic Development

Figures 4,5 and 6 show scatter plots on the relationship between bond financing size and the stage of economic development.

Government Bond and Stage of Economic Development

Table 4 presents the simple regression results on the relationship between bond financing size and stage of economic development.

Table 4. Relationship between Types of Bond and Stage of Economic Development

Model

Total Bond

Government Bond

Corporate Bond

In GDP per capita

Intercept

Slope

Intercept

Slope

Intercept

Slope

Coefficient

-2.046

0.283**

-0.8760***

0.133***

1.1712***

0.1495**

Standard error

0.3044

0.033

0.3103

0.033

0.1607

0.0175

t-stat

-6.7222

8.495

-2.822

3.929

-7.287

8.5054

p-value

4.46E-0

2.77E-1

0.0062

0.000

4.3E-10

2.65E-1

R Square

0.5148

0.1850

0.515

Note: Note: Significance tests: *** means significance at 1% level: p<0.01, ** means significance at 5% level: p<0.05, and * significance at 10% level p<0.1

The data in Table 4 and graphs 4, 5 and 6 show that all slopes among the three are significantly different than zero. The t-statistics of government bond is significant at the 1% and rest are significant at the 5% level. Therefore, the stage of economic development is a key determinant of all types of bond financing. Among the bond markets, total bond and corporate bonds have very high r-squared value of 0.51.This means that 51% of the variance in the dependent variable can be explained by the regression equation.

4.1.3 Relationship between Types of bonds and Openness of the Economy

Table 5 below presents the simple regression results on the corporate financing relationship with openness of economy. The slope coefficient for corporate bond financing is only significant at the 5% level. Among the three, the r-square of corporate bond at 0.05 means that only 5% of the variance in the dependent variable can be explained by the regression equation. The fit is poor. The rest have a very low value and may not give a good explanation.

Table 5: Relationship between Types of Bond Openness of the Economy

Model

Total Bond

Government Bond

Corporate Bond

Exports (% to GDP)

Intercept

Slope

Intercept

Slope

Intercept

Slope

Coefficient

0.517***

0.019

0.396***

-0.120

0.122**

0.139**

Standard error

0.079

0.138

0.062

0.108

0.041

0.071

t-stat

6.502

0.136

6.380

-1.116

2.970

1.957

p-value

1.1E-1

0.892

1.81E-08

0.268

0.004

0.0544

R Square

0.0002

0.0179

0.0533

Note: Significance tests: *** means significance at 1% level: p<0.01, ** means significance at 5% level: p<0.05, and * significance at 10% level p<0.1

4.2 Results of Multiple Regression Analysis

The estimated fixed effect model equation is: , where

Yit = total bond, government bond or corporate bond (in % of GDP) of country i at time t ,

X1it = GDP of country i at time t,

X2it = PPP GDP per capita of country i at time t,

X3it = Export to GDP ratio of country i at time t,

i = 1,2….., 10

t = 2000, 2001… 2006

The table 6 presents the empirical results three multiple regression for total, government and corporate bind as dependent variables. The objective is to test the main hypotheses of (i) the

economic size of a country has a positive relation with its bond market development; (ii) openness of an economy has a positive relation with its bond market development; and (iii) the stage of development of an economy has a positive relation with its bond market development.

Table 6. Determinants of Bond Financing—Multivariate Fixed-Effect Model Estimates

Dependant variable/Independent Variables

Total Bond

(% to GDP)

Government Bond

(% to GDP)

Corporate Bond

(% to GDP)

time

0.099***

(0.019)

0.106***

(0.025)

-0.006

(0.009)

GDP

-4.632***

(1.092)

-4.968***

(1.211)

0.303

(0.783)

GDP Per Capita, PPP ($)

3.874***

(1.006)

3.994***

(.1.059)

-0.090

(.819)

Export to GDP (%)

0.368

(.312)

0.580

(.0.344)

-0.218

(.131)

Constant

-173.265***

(33.596)

-183.516***

(43.496)

9.767

(16.459)

No. of Groups

10

10

10

No. of Observations

66

66

60

Estimation Period

2000-2006

2000-2006

2000- 2006

Note: Robust standard errors are reported in parentheses. Significance tests: *** means significance at 1% level: p<0.01, ** means significance at 5% level: p<0.05, and * significance at 10% level p<0.1

The coefficient of the trend variable is significant for total and government bond but not for corporate bond which unexpectedly has a negative sign. This proves that the trend variable is capturing the omitted key determinants, such as exchange rate risk, interest rate spread, bank concentration etc. as considered by Eichengreen and Luengnaruemitchai (2004).

The export to GDP ratio also could not explain the size of bond market for all types of bond. This may be due to a distortion in the data as Indonesia and Hong Kong, China showed a decreasing trend in this variable between 2000-2006 (Table 2).

According to the results the variable GDP representing the size of an economy is negatively significant at the 1% significance level when regressed against total bond capitalization and government bond capitalization and this result is in contradiction to our expectation. However, the significance of the variable indicates that the size of the economy has a strong and important relationship with bond market development in a country. The coefficient of corporate bond model with GDP has the right (expected) positive coefficient but it is not significant.

As corporate bond financing size is quite small in emerging Asia and growth in this market has been limited, the empirical analysis could not give meaningful results.

The variable GDP per capita is positively correlated when regressed against total and government bond capitalization since the t-statistics is significant at the 1% significance level. Further the result is consistent with the earlier study of Eichengreen and Luengnaruemitchai (2004) and it reveals that the stage of economic development is one of the strong determinants of the bond financing size or bond market development.

5. Conclusion

There is an urgent need to further develop local currency bond markets in East Asia to provide alternative sources of corporate financing for the public and private sector. In this regard, it is important to examine the factors that affect the effective development of bond markets. This paper first time attempts to examine empirically the relationship between types of bond financing and their key determinants exclusively for Asian countries.

With respect to bond financing or bond market development, the empirical analysis indicates that bond market development, measured by total, government and corporate bonds is strongly associated with the stage of economic development as measured by per capita GDP in US $ PPP. However, unlike an earlier study, the results of the regressions conducted have not shown any significant relationship between bond market in an economy and the openness of the economy measured in terms export to GDP ration and significant but inconsistent relationship with the economic size.

One limitation of the study is that the number of observations is not adequate. The history of emerging Asian economies bond market is very recent. At the same time, the sample of countries is very diverse with Japan, a developed country with a huge bond market (166% pf GDP) and on the other hand Viet Nam with very small size of bond market (8% of GDP). These two countries could be outliers and may have distorted the results.

Further research using other key determinants or additional factors such as exchange rate risk, interest rate spread, bank concentration may be able to better predict the relationship with bond market development in a country. Moreover, considering other qualitative factors such as level of corruption, accounting standards, type of bureaucracy in the economy can also be considered in the regression analysis to examine the relationship involving bond market development in a country.

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