Asia-Pacific's investment-grade debt markets are in a cyclical sweet spot. This is according to investors, who cite positive policy shifts and the fact that many corporates are in a recovery-and-repair phase after a difficult few years. The credit cycle is trending up, they say, and the rates cycle is trending down.

We draw our comments from a conference S&P Global Ratings hosted on Feb. 21, 2024, titled, "Asia Corporate Outlook 2024: China's New Year, Asia's New Cycle." Market participants talked about how low supply has propped up demand for dollar bonds, as issuers in the region increasingly turn to local debt markets. The emergence of dual-currency funding for issuers, as local funding and liquidity deepens, will underpin tight supply in the G3 bond market (debt in U.S. dollars, euros, and yen) in the years to come.

Policy changes are supporting growth in China. The Chinese government is moving away from the old mode of growth to something that is perhaps more sustainable. Authorities are also shifting their approaches to provide more support to the country's housing market. To manage coming changes, panelists emphasize the need to differentiate among sectors and countries in Asia-Pacific.

We present the key takeaways of views expressed in the frequently asked questions below.

Questions discussed include:

• What are the key themes in global credit markets this year?
• How do investors see Asia and China investment-grade credits this year?
• How do investors view government support risks for state-owned enterprises (SOEs)?
• Which Asian sectors will be weaker in 2024?
• What's the outlook for Asian G3-currency bond issuance for this year?
• What big changes are coming to Asia's bond markets?

A replay of the event is available here.

Frequently Asked Questions

What are the key themes in global credit markets this year?

Gregg Lemos-Stein (S&PGR):  Globally, the credit outlook is surprisingly sanguine. We've had more resilience than we expected, and we are getting the soft landing we were hoping for. Market conditions are better. Liquidity is there, refinancing can get done, and the macro environment seems supportive despite high financing costs.

That said, global rating actions are still net negative, and the trend is persisting, driven largely by 'B-' and 'CCC' credits heading into default. These firms tend to have a ratio of free operating cash flow to debt of 2.5%-3%, which would be wiped out by base rates rising to over 5% from effectively zero before early 2022.

For investment grade, this is not an existential risk, as such entities tend to have free operating cash flow to debt ratios of 20%-25%. This difference will drive the higher and lower end of the credit spectrum to diverge as defaults rise this year and peak next year.

Lastly, massive investments are needed for energy transition, artificial intelligence (AI), chip factories, data centers, etc. This will propel huge demand for debt, and will be the next tailwind to watch.

Chart 1

How do investors see investment-grade credits in Asia this year?

Jenny Zeng (Allianz):  Although the pace of inflation and Fed cuts are unclear, we have relatively high conviction that the volatility of U.S. Treasuries will fall, and their trading range will narrow. This provides a benign environment to take carry risk.

Most sectors in Asia are in the sweet spot of the credit cycle--the repair-and-recovery phase. We use them to build a core portfolio, then add from sectors in the parts of the cycle with more credit deterioration and more alpha. For example, firms in expansion with more capital expenditure (capex), and firms facing downcycles with more default risks. If a core portfolio can generate 8%, adding alpha from these sectors could get that up to double digits.

Soo Chong Lim (JP Morgan):  In Asia, we have seen the worst of the credit cycle, whether in downgrades or defaults. There are macro headwinds, but the damage will be well contained. Spreads are tight, but all-in yields are at the top end of the historical range. They are now at 6.5% for the JP Morgan Asia Credit Index (JACI), and 5.5% for pure investment-grade. This year, we expect 8%-9% total return from JACI, versus 7% last year.

Investors are showing a lot of interest in India, but they remain underweight in most other Asian countries. India investment-grade is now trading inside China, despite big rating differentials. Indonesia also tightened a lot, but investors are still interested in its macro story, and there may be some opportunities at the longer end of the curve.

Omar Slim (Pinebridge):  Investment-grade spreads are tight from a historical perspective wherever you look, and they will likely remain tight, whether it's 'BBB' rated issuance or above, in Asia, the U.S., or Europe. However, most of our conversations focus on overall yield, which is, from a historical perspective, more interesting to investors.

Chart 2

How do investors view China investment-grade credits this year?

Soo Chong Lim (JP Morgan):  Despite the negative headlines, China investment grade performed well, even versus developed markets. If you strip out property, it delivered a 7%-8% return last year, outperforming many other markets. This is due to technical factors, such as strong demand from Chinese commercial banks. Some of them have foreign-currency deposits not lent out onshore, and those funds tend to go into the market.

Omar Slim (Pinebridge):  China investment-grade paper is still 25%-40% of the market depending on which index you use. We don't subscribe to the view that China is uninvestable. Despite the negative news, a large part of China investment-grade is still tight, reflecting a strong bid for the bonds. Investors tend to own it, hold it, and keep it.

Jenny Zeng (Allianz):  In China, we have seen policy shifts that we haven't seen in past decades. The step-up in both monetary and fiscal support will put a floor on growth. However, Beijing is not going back to its old growth model, which relies too much on channeling excess savings to unproductive investments. This shift will require corporates, households, and local governments to adjust their expectations.

Another shift is in the property sector. China's real estate crisis is unique in that it is not a crisis of demand but one in its presale model. Last year, primary sales dropped a lot, but secondary sales were up significantly. In what property crisis do you see people stop buying primary but keep buying secondary?

Homebuyers are saying: we don't want to take the credit risk of the developers on our balance sheet anymore. Only in China do buyers put up 100% of the value of the home right after buying. In other markets, one pays a deposit, then pays according to construction progress.

Because this is not a demand crisis, traditional demand-side policies are not working well. This is why the policy focus is shifting to restoring buyer confidence by supporting projects through "white lists."

How do investors view government support risks for state-owned enterprises (SOEs)?

Omar Slim (Pinebridge):  For Asian SOEs--for example, those in Southeast Asia--the environment is more benign than in China, and the risk is more idiosyncratic. Many of these names are perceived to be sovereign risk for good reason.

Chinese SOEs are different. The policy direction is what matters for such entities. It is what moves markets and what drives credit metrics.

State support will be targeted. We generally have more comfort with large, systemically important SOEs, but we consider whether that support is conditional. The big four asset management companies, for instance, are systemically important, but their support comes with strings attached.

We became cautious on Chinese SOEs four years ago, when we saw a policy shift that we thought would manifest in diminished support for some segments.

Beijing is still managing systemic risks, but their threshold for allowing defaults increased substantially. Now they draw the line at those that are big enough to trigger systemic risks or large societal impact.

Chart 3

Which Asian sectors will be weaker in 2024?

Junhong Park (S&PGR):  In Korea, the proportion of rated firms with negative discretionary cash flows, or operating cash flows minus capital spending, is much larger than other Asian countries. More Korean firms are investing in technology or energy transition, such as electric vehicle (EV) manufacturing, batteries, and materials.

We see this among many of our 'BBB' category Korean names, such as SK hynix Inc. investing in memory chips, SK Innovation Co. Ltd. in EV batteries, and SK E&S Co. Ltd. in renewable energy. Their financial policy has been aggressive, pushing up their leverage. That trend is continuing.

SK group as well as LG Energy Solution Ltd. and Samsung SDI Co. Ltd. also have big project pipelines in the U.S. These projects may have credit implications as EV growth slows.

Other weaker sectors include chemicals and steel, as they are facing oversupply and weaker demand, particularly in China.

Chang Li (S&PGR):  Market sentiment is still weak for China's property sector. We expect national sales to fall a further 5% this year despite several rounds of policy support. As a result, developers will continue to see pressure on sales and margins this year.

China's traditional auto sector may also show some weakness. We have lowered our growth estimate of domestic light vehicle sales to 0%-2% in 2024, due to the slowing economy and weak spending on big-ticket items. Intensifying competition in the country will also weigh on profitability and cash flow.

Omar Slim (Pinebridge):  We continue to be extremely cautious on several Chinese segments that we think will continue to struggle. This includes smaller financials, local governments, and China property developers.

We did our own stress scenarios using shocks from nonperforming loans among mortgages and loans to developers and their projects. We concluded China's banks can absorb significant volumes of bad loans, but not equally. Large financial institutions can take it, but some smaller ones may need support.

What's the outlook for Asian G3-currency bond issuance for this year?

Vijay Jote (BNP Paribas):  Issuance this year will be more than last year. Spreads are tight, yields are attractive, and some firms do have interest to issue. They are preparing timetables to adapt to expected rate cuts. Utilities firms may be interested in transition financing, and the usual tech, industrial, and consumer names may also want to issue, although issuance by property developers still looks unlikely.

Among sectors, transition financing still has a lot of potential, especially in Asia-Pacific. Many brownfield projects have an energy-transition angle. Also, an issuer may have a parent that sees energy transition as a core strategy, and both could issue.

Junhong Park (S&PGR):  Korean firms investing in AI, semiconductors, and the EV value chain need funding. They may issue. Although domestic funding costs are cheaper, they may prefer offshore issuance to match their overseas investment needs.

Chang Li (S&PGR):  Some Chinese firms are expanding overseas as growth slows at home and as import restrictions rise in the U.S. We may see this from more EV makers and tech firms. Although their issuance plans this year remain unclear, the offshore bond market will remain an important funding channel for them.

What big changes are coming to Asia's G3-currency bond market?

Jenny Zeng (Allianz):  In Asia, the important change is that the region used to be a dollar system, now we are moving to a dual-currency system. In the next five to 10 years, Asia credit will become U.S. dollars plus local currency.

Issuers in many markets such as India will ask why issue in dollars when the local market is cheaper and has better liquidity. They no longer have to issue in dollars. Investors will need to adapt.

Soo Chong Lim (JP Morgan):  If geopolitical noise drives foreign holders to sell, we expect the Chinese banks to come in. We saw this a few times already last year. It used to take weeks for the market to recover from such hits. Now it takes just days.

Omar Slim (Pinebridge):  Demand is strong, and cash holdings are high. There are also more buy-and-hold investors, which used to be more common for the 'AA' and 'A' rated firms, but now include 'BBB' rated entities as the market shrinks amid negative net issuance over recent years.

Many investment-grade names can fund onshore or are very well-banked. They don't need to go to the market. This has led to a scarcity in issuance, which has anchored the tight spreads in Asia.

Editor: Jasper Moiseiwitsch

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