Underlying credit metrics. Another important consideration for reserve managers is credit risk as measured by the level of public indebtedness.
As mentioned earlier, Asia’s public debt to GDP ratios are distinctly superior. The Asian Tigers comprising Korea, Taiwan, Hong Kong and Singapore had a public debt-to-GDP ratio of 41% (GDP-weighted) at end 2011. Emerging Asia’s ratio was even lower at 35% of GDP.
This compares with debt ratios of 47% for Emerging Europe, 50% for Latin America, and 104% for advanced economies. Only the Mena region, with 25% of GDP, had a lower debt ratio than Emerging Asia.
In addition, Asia (including Japan) held 60% of all foreign exchange reserves and seven of the ten largest reserve holders globally were from Asia. A large stock of foreign assets reduces credit risk considerably.
Asia’s superior credit has also been reflected in sovereign ratings. For each emerging market, we averaged the credit ratings by the three main rating agencies. We then aggregated country ratings to regional ratings on a GDP weighted basis.
We found that Emerging Asia had a credit rating of A, followed by Latin America (A-), Emerging Europe (BBB), and the Mena region (BBB-). Using the same country weighting, we also found that Emerging Asia exhibits significantly lower CDS (credit-default swap) spreads, namely 135 basis points – compared with 245 basis points for Latin America, 255 basis points for Emerging Europe, and 290 basis points for the Mena region.
Market depth and liquidity. The importance of this criterion cannot be overemphasised. In fact, the bias of reserve managers towards dollar-, euro- and yen-denominated assets, despite the deterioration of their sovereign’s creditworthiness, has been a reflection of the depth and liquidity of these markets.
The 2010 Triennial Central Bank Survey on Global Foreign Exchange Activity by the Bank for International Settlements provides data on foreign exchange turnover by currencies. The spot turnover of all Emerging Asian currencies listed in the survey summed up to US$91 billion per day.
This is small compared to the spot turnover of the dollar (US$1,200 billion), euro (US$700 billion) and yen (US$300 billion), not even adjusting for the fact that we are dealing with a multitude of currencies, rather than one single currency.
However, the spot turnover of Emerging Asia currencies is much higher than the cumulative spot turnover of Emerging Europe or Latin American currencies listed in the survey: US $39 billion and $27 billion, respectively.
The trend of liquidity in Emerging Asian currency markets has also been encouraging. Over the past 10 years, spot turnover increased from US$19 billion to US$91 billion, a five-fold increase. This compares with a five-fold increase for Emerging Europe, a three-fold increase for Latin America, and a 3.5-fold increase in US dollar spot transactions over the same period.
Asia’s advantage over other emerging markets becomes more pronounced if we compare both spot and forward turnover. This makes sense, if a majority of countries allow arbitrage between the onshore and offshore (forward) markets.