East Asia’s local-currency bond markets grew 15% in the third quarter from a year earlier as governments and companies took advantage of lower interest rates to fund spending, the Asian Development Bank said Tuesday. Outstanding local currency bonds in emerging East Asia stood at $4.2 trillion at the end of September 2009, up 14.8% over 12 months and nearly eight times more than at the end of 1996, shortly before the onset of the Asian financial crisis. However, the market remains small compared with the US and Japan.

The November issue of the Asian Development Bank's (ADB) Asia Bond Monitor  attributed the increase to local currency bonds' growing role as a source of funds for companies and governments - - recently to support economic stimulus packages - - and to market reforms.

"The increase in emerging East Asia's outstanding bonds to above $4 trillion is testament to the hard work of the region’s governments and regulatory authorities in opening up their markets with an eye to building a regional debt market," said Jong-Wha Lee, ADB's chief economist.

While the gains are impressive, the ADB said governments must continue efforts to develop their markets further, according to the report. Emerging East Asia - - comprising China PRC - - People's Republic of China) ; Hong Kong Indonesia; South Korea; Malaysia; Philippines; Singapore; Thailand; and Vietnam - - currently makes up around 6% of the global bond market, which is up from only 2% in 1996. However, this is still well below Japan's 17% and over 42% for the US.

Growth in emerging East Asian bond markets was particularly strong outside China. Excluding China, markets were 16% larger than at the end of September 2008. Growth in China moderated to 13.9% year-on-year in the third quarter from 14.8% in the April to June period.

The sharpest growth rate in the region’s markets was in Hong Kong, which grew 39% versus a year earlier due to significant issuance of Exchange Fund Bills and Notes for monetary purposes, as well as two large sales of new Special Administrative Region issues to aid local market development. The Indonesian local currency bond market expanded 18.1%, while the Singapore dollar bond market grew 17.3%.

Government bond issuance grew fastest in Hong Kong; South Korea and China. Meanwhile, corporate issuance expanded the most in Vietnam, Indonesia, and China.

Although issuance has gone up, spreads have tightened, and turnover has increased since the height of the global financial crisis. The ADB said risks remain to emerging East Asian bond markets, notably uncertainty about the robustness of the global recovery and inflationary pressures, premature monetary or fiscal tightening, and potentially volatile capital flows.

The ADB says more work needs to be done to bolster liquidity in local bond markets, according to the AsianBondsOnline Annual Liquidity Survey, which accompanied the quarterly Asia Bond Monitor. Liquid bond markets help in the effective transmission of monetary policy and the creation of reliable pricing benchmarks.

In the survey of 106 participants conducted in June and July, respondents agreed that increasing the diversity of the investor base is key to improving liquidity. Currently, banks and financial institutions constitute the dominant investor class in most government bond markets in Asia. Respondents also pointed to the need for better tax treatment and suitable hedging instruments.

"It's clear that despite all the developments in recent years, the region needs to further broaden the investor base, strengthen market infrastructure, and put in place a sound regulatory framework so that fixed income markets can play their full role in the region's economies," said Lee.