Asian governments have prided themselves on their admirable fiscal restraint and large budget surpluses. Yet this remarkable prudence has had the unintended consequence of hampering the development of local capital markets.1
For such markets depend on the steady, reliable issuance of government debt, and its absence has stunted their development in Asia. Asian companies have looked to banks for much of their corporate financing, relying on short-term working-capital loans in domestic and foreign currencies. The crisis of 1997 and 1998 revealed the grave dangers of this system. Without the continuous scrutiny of investments, the long-term funding instruments, and the repricing of risk offered by capital markets, Asian financial systems piled up a mountain of bad loans that eventually culminated in the debacle.
To avoid such disasters in the future, Asian countries should develop their capital markets and their capacity for prudential regulation. A critical building block in that process is the development of a healthy market for government bonds.
Way behind
In size and liquidity, Asian bond markets lag woefully behind their counterparts in the West (Exhibit 1). Apart from Hong Kong, Japan, and Singapore, few governments have issued enough different maturities to establish a yield curve. In...