Optimism is returning to South and Southeast Asia. S&P Global Ratings recently estimated that GDP growth in India will reach 11% for the year ended March 31, 2022, compared with an 8% decline for the year ended March 31, 2021. Average GDP growth in Southeast Asia will reach 6.2% in 2021 compared with a 4.3% drop in 2020.

We also project a 5%-15% increase in EBITDA for rated companies in the region in 2021 over 2020, with profits growing year on year for nearly nine companies out of 10.

Yet, liquidity conditions remain tenuous, especially for weaker-rated issuers. Capital markets are likely to stay volatile for the rest of the year, despite a recent fund-raising window for speculative-grade issuers. Bank lending is selective. We believe widely available liquidity is the missing piece necessary for a broader credit recovery in the region, even as economies and profits rebound.

Unpredictable access to capital and refinancing for weaker issuers in South and Southeast Asia is likely to create a spike in default rates if volatile funding conditions persist beyond the third quarter of 2021. With corporate ratings at 'B-' or below for over 10% of rated companies in South and Southeast Asia, default rates on the rated universe in the region could reach 5% over the next 12 months, nearly twice the level of 2020.

Refinancing Risk And Liquidity Drive Negative Corporate Rating Bias

Despite recovering profits, we retain a negative outlook on about one-third of our ratings on issuers in South and Southeast Asia (see chart 1).

Chart 1

For speculative-grade names, liquidity and refinancing explains almost 60% of these negative outlooks (see chart 2). There were numerous issuances from South and Southeast Asia in 2017-2018, with close to US$45 billion coming due by 2023. About US$14 billion of those are speculative-grade bonds, whose refinancing success will be reliant on funding availability and more sensitive to investor confidence and capital market conditions.

Chart 2

Amid this steep maturity wall (see chart 3), most conversations we have with investors focus on the question of liquidity and the ability of companies to refinance. We see the possibility that capital markets may stay volatile through 2021, with bank funding remaining selective.

Chart 3

Capital Markets Are Open…To A Happy Few

Capital markets in Asia-Pacific are set to stay polarized through 2021.

Financially solid corporate issuers with resilient earnings or government support have been accessing the market at spreads that are near all-time lows. Issuers rated at investment grade by any of the three international credit rating agencies increased U.S.-dollar issuance by 50% in the first quarter of 2021, compared with the same periods in 2020 and 2019, across Asia-Pacific.

The picture is different for weaker credits. Speculative-grade corporate issuance has been much more volatile in Asia-Pacific, and in South and Southeast Asia in particular. In the first quarter of 2021, Asia-Pacific firms' U.S. dollar issuance that was rated by any of the three international rating agencies was down more than one-third from the level seen in the same period in 2019 and 2020.

Chart 4

Hit or miss fund-raising initiatives suggest to us that improving investor sentiment toward speculative-grade issuers in South and Southeast Asia does not appear to be firmly entrenched. Market timing is as much of a factor for a successful transaction as credit fundamentals.

In South and Southeast Asia, Indian miner Vedanta Resources Ltd. (B-/Stable/--) issued a three-year U.S.-dollar bond in December 2020 with a coupon of 13.875%. It returned in February 2021 with a slightly longer dated four-year transaction that paid 8.95%. While there were positive developments specific to the entity, more favorable market conditions at the start of the year also accounted for the tighter coupon.

Greenko Energy Holdings (B+/Stable/--), an India-based power producer, issued a bond yielding a tight 3.85%. And PT Japfa Comfeed Indonesia Tbk. (BB-/Stable/--), issued a 5.375%, five-year bond in March at a coupon rate slightly below that of its 2017 bond.

Yet, a number of high-yield transactions are also being cancelled or postponed, including three in the textile and palm oil sectors in Indonesia. This suggests that investors remain selective, especially toward issuers with weaker earnings quality, working capital challenges, complex corporate structures, or weaker governance.

We think investor sentiment toward higher risk credits in South and Southeast Asia will only stabilize when the recovery is firmly under way, and when there is clear progress on a vaccination roll-out. This could be a few quarters away in the region.

A much sharper recovery in the U.S. than we currently expect presents another type of downside risk for South and Southeast Asian speculative-grade issuers. If a U.S. recovery pushes up interest rates and prompts investors to reassess inflation expectations, this may prompt foreign investors to temporarily shun higher-risk corporate issuers in the region. This dynamic was seen during the taper tantrum of 2013, and the currency depreciations of 2015, 2018, and 2020.

Domestic capital markets may pick up some of the slack, but only in Thailand, Malaysia, and Singapore. Those are the only regions where the local currency corporate bond market exceeds one-quarter of domestic GDP, according to the Asian Development Bank.

Domestic capital markets in Indonesia or the Philippines are too shallow to allow a substantial refinancing of maturing U.S.-dollar notes. In Indonesia, benchmark issuances for private companies in the domestic market are rarely above US$100 million. Even the larger conglomerates or state-owned companies only infrequently issue above US$200 million. In both countries, the size of the local-currency corporate bond market to domestic GDP is below 10% and has stayed at these levels for the past decade.

Bank Credit: Selectivity Is The New Order Of The Day

To be sure, banks in the region are flush with liquidity, due to a slowdown in loans growth and the buildup in deposits from 2020.

Our banking analysts anticipate a pickup in credit growth across the region in 2021. They also expect credit growth will revert to pre-COVID levels in 2022 (see table). At the same time, we note that lenders in the region have turned somewhat more stringent in underwriting standards. This follows a spike in defaults over the past year and rising credit costs. We project nonperforming loans to be nearly double their pre-COVID levels in 2021 for banks in Thailand, the Philippines, and Malaysia, while staying elevated in India (see chart 5).

Chart 5

With credit costs likely staying high through 2022, bank lending should stay selective. Banks are already favoring the larger and higher-quality borrowers or clients with established relationships and a long record of bank support through a credit cycle.

This working capital crunch has been particularly significant in Indonesia. The banking system in that country has been selective in lending to the working capital-intensive sectors such as construction, textile, real estate, retail, and light manufacturing. Working capital loan disbursement fell nearly 5% in Indonesia in 2020, the largest drop among lending categories, according to commercial bank data provided to Indonesia's Financial Services Authority OJK.

There is also growing selectivity in disbursing funding to Indonesia's weaker state-owned enterprises, as government support to these companies is also turning increasingly selective.

Working capital requirements are bound to grow for the corporate sector as revenue growth recovers and companies in the region rebuild their inventories. More widespread working capital is an essential factor for a broader-based recovery. Its return would stabilize corporate credit conditions in South and Southeast Asia. We view the sometimes strained working-capital conditions as indicative of broader liquidity challenges, as much of this region continues to battle a deep health crisis.

Related Research

• Economic Outlook Asia-Pacific Q2 2021: Three-Speed Recovery Will Benefit From Faster Global Growth, March 25, 2021
• Central Banks, Credit Markets, And The Catch-22 Taper, March 23, 2021
• Emerging Asia's Recovery Can Withstand A Reflation Trade, March 17, 2021

Writing: Jasper Moiseiwitsch