Chapter 3. Financing a sustainable recovery from the COVID-19 pandemic

All around the world, the COVID-19 pandemic has exposed gaps in healthcare systems, disrupted businesses and public services, derailed supply chains, and shattered job markets (see Chapters 1 and 2). Although conditions have improved in many countries as vaccination rates have increased, recovering from one of the biggest global socio-economic crises in decades will involve many challenges, particularly for Emerging Asian economies.

Ensuring the availability of suitable financing in a way that does not put the stability of financial markets and fiscal policy at risk is a critical consideration as governments address the challenges of the pandemic. As it stands, Emerging Asian governments do have some room for manoeuvre, yet they are also dealing with rising levels of fiscal stress. Against this backdrop, this chapter aims to contribute to policy making by discussing financing options for the public sector in detail. In so doing, it presents options for financing policies in a more sustainable manner.

Firstly, the chapter sets out a number of ways in which governments can manage their current stock of debt. It then looks at how they can narrow financing gaps by harnessing bond markets, and at policies that can deepen the markets for government debt. More specifically, it looks at how green, social and sustainability bonds can be used to finance a sustainable and equitable recovery from the pandemic. The chapter then discusses insurance-linked securities, and the role of multilateral institutions in lowering the cost of credit. Finally, it reviews regional risk-pooling mechanisms to hedge potential losses from catastrophic events.

As the pandemic drags on, the economic environment remains challenging, and designing fiscal and monetary interventions is increasingly complex. Considering the tightness of their fiscal headroom, policy makers face a trade-off between maintaining policy support in the near term, and preserving financial stability in the medium term. At this juncture, there is still arguably some space for governments in the region to intervene in many Emerging Asian economies; although constraints could harden if a new wave of COVID-19 cases were to stress healthcare systems, or if monetary policies began to tighten in response to increasing inflationary pressure.

The COVID-19 pandemic has significantly increased the pressure on public finances due to supportive measures such as cash-transfer packages and higher healthcare budgets. In certain cases, governments in the region have already had to reduce or suspend some expenditure items in favour of the pressing need to lessen fiscal burdens. The ratio of general government spending to gross domestic product (GDP) in the region has risen markedly, increasing to a range of 18-37% in 2020, from 14-34% in 2019 (Figure 3.1). The uptick in spending to manage the response to the pandemic coincided with a drop in revenues as economic activity fell back. Still, the spending-to-GDP ratio is expected to stabilise by the end of 2021, and decline in 2022, as governments rein in their budgets.

Near-term fiscal concerns mostly revolve around the debt-service burden of an economy, and data on this seem to provide some grounds for reassurance. Still, the rather muted changes in interest payments thus far have been against a backdrop of persistently low interest rates across Emerging Asia, a trend that will be discussed in detail in the subsequent section. Meanwhile, general government borrowing as a proportion of output jumped sharply across Emerging Asian economies in 2020. Moreover, it is anticipated to continue to inch upwards in some of the countries in 2021, albeit at a slower pace. Indonesia, Malaysia, Myanmar, the Philippines, Thailand, and Viet Nam are projected to record higher net borrowing ratios by the end of 2021 compared to 2020, before these ratios begin to recede.

The widening deficits expectedly led to a significant rise in governments’ stock of debt (Figure 3.2, Panel A) after the outbreak of the pandemic. The public debt of Emerging Asia (excluding Brunei Darussalam) increased by an average of 15.5 percentage points from 2019 to 2020. Moreover, debt levels are forecast to have risen by the end of 2021. With GDP levels generally declining in 2020, debt-to-GDP ratios have surged by an average of about 9 percentage points since 2019 across the 12 economies of Emerging Asia. Public debt ratios at the end of 2020 ranged from roughly 2.9% in Brunei Darussalam, to 154.9% in Singapore (Figure 3.2, Panel A). Notably, the general government gross debt ratios of Singapore, the People’s Republic of China (hereafter “China”), India, Cambodia and Thailand hit all-time highs in 2020. In parallel, fiscal deficits have widened sharply in 2020 in all countries in Emerging Asia and are anticipated to have deteriorated further in 2021 in Indonesia, Malaysia, Myanmar, the Philippines, Thailand and Viet Nam (Figure 3.2, Panel B). Furthermore, a comparison with the pre-pandemic period 2010-2019 shows that both debt levels and fiscal deficits have deteriorated markedly in 2020 and 2021 compared to that period.

As sovereign debt has increased sharply worldwide, the question of its sustainability has come to the fore. The standard framework of analysis suggests that four main factors determine debt sustainability: the initial level of debt, economic growth, the degree of fiscal balance, and the burden of debt-service (Bohn, 1998). Box 3.1 provides a brief overview of the general considerations and features of the fiscal frameworks that governments adhere to. Fiscal frameworks are indeed an important tool for supporting fiscal sustainability and increasing the predictability of public policies. Another important attribute of fiscal frameworks is that they facilitate communication with – and accountability to – the public.

In practice, however, markets’ tolerance of debt levels necessitates a case-by-case analysis. The precise thresholds are a matter of market judgement and can be dynamic or change over time.

The OECD countries implemented various policies in terms of securing long-term fiscal sustainability. Medium-term expenditure frameworks, for example, are an important tool for overcoming the limitations of the annual budget cycle by adopting a medium-term perspective (i.e. at least three years from the current budget) for achieving fiscal objectives (OECD/ADB, 2019). Another tool is performance budgeting, which has been widely adopted by OECD countries starting from the 1990s. Performance budgeting is defined by the OECD as “the systematic use of performance information to inform budget decisions, either as a direct input to budget allocation decisions or as contextual information to inform budget planning, and to instil greater transparency and accountability throughout the budget process, by providing information to legislators and the public on the purposes of spending and the results achieved” (OECD, 2019).

Spending reviews represent an additional tool for streamlining fiscal management. They entail an assessment of the implementation efficiency and effectiveness of existing government policies and have proven to be an important tool for governments to control total expenditure, to align spending allocations with government priorities and to improve the effectiveness of policies and programmes (OECD, 2021a). In addition, independent fiscal institutions (i.e. independent parliamentary budget offices and fiscal councils) have been established across OECD countries to “provide independent analysis of fiscal policy and performance, thus promoting fiscal transparency, sound fiscal policy and sustainable public finances” (OECD, 2020a). Finally, green budgeting frameworks could support the achievement of environmental and climate-related objectives by providing policy makers with a clearer understanding of the environmental and climate impact of budget choices. Green budgeting relies on four key mutually reinforcing building blocks, namely: a strong strategic framework; tools for evidence generation and policy coherence; reporting to facilitate accountability and transparency; and an enabling budgetary governance framework (OECD, 2020b).

Drawing on the lessons of the Asian financial crisis of 1997-98, and in order to mitigate risks related to exchange rates, governments in Emerging Asian economies have favoured domestic sources of credit over external ones. Since the crisis, Emerging Asian economies have been especially keen to keep their external public debt-to-GDP ratios in check. In 2020, public and publicly-guaranteed external debt did rise, however, driven by spending on support measures to ride out the pandemic (Figure 3.3).

For many countries in the region, multilateral development banks and official bilateral sources have stepped in to meet a substantial chunk of long-term foreign currency financing demands of their public sectors (Figure 3.4). The exceptions are China, which relied more on private creditors, and to some extent, Thailand.

Thus far, credit rating agencies have arguably been more flexible than in previous years in applying their ratings frameworks in their assessments of credit risk despite the marked rise in the gross sovereign debt stock. In Emerging Asia, save for the four rating downgrades outlined in Table 3.2 (i.e. dark orange cells), credit rating agencies have mainly adjusted their outlooks downwards. The changes were also not unanimously on the downside, with Viet Nam receiving outlook upgrades in the first half of 2021 from all three of the major credit rating agencies.

Apart from containing expenditure and targeting it more effectively, there is also scope for governments to improve revenue collection through specific policies. For instance, the digital economy, which has grown rapidly in Emerging Asia in the past few years, is a potential avenue to expand the tax base. At the same time, governments can also leverage digital tools more than they already do, in order to facilitate compliance and improve tax administration (Box 3.2). However, it should be acknowledged that tax increases may be difficult to implement in the post-pandemic recovery phase and are thus not the first option of choice.

The financial standing of the private sector has also been badly hit by the pandemic in Emerging Asia. Notwithstanding the support measures that governments have implemented, many firms – particularly micro, small and medium enterprises (MSMEs) – have closed down. Interestingly, Vandenberg (2021) provides evidence that bankruptcies have actually fallen in some relatively high-income economies in Asia over the course of the pandemic, but also notes that enterprises may fail or close permanently without actually undergoing an insolvency or bankruptcy procedure. The author posits that the lower number of bankruptcies could be associated with the speed and “unreservedness” of government stimulus measures. If enterprises that have so far managed to avoid bankruptcy thanks to government support measures are to continue surviving, the author contends that “measures need to continue until economic recovery takes hold”.

In some countries in the region, private sector debt-to-GDP ratios are already well-over 100% of GDP (Figure 3.5). In China, the ratio even exceeds the average levels of emerging and advanced economies alike. This is a critical metric because the pandemic has placed enormous pressure on corporate earnings and ultimately on the serviceability of private debt. Meanwhile, as anticipated, the share of non-performing loans to gross loans in some Emerging Asian countries went up in 2020 and 2021 (Figure 3.6). While the absolute ratios remain arguably generally benign, the large share of big firms in the aggregate borrowing figures, and the significant degree of regulatory forbearance in facilitating the restructuring of loans, may have masked the severity of the situation.1, 2 Indeed, the impact on MSMEs, which already were underfinanced by formal credit channels even before the pandemic, may only be partially captured.

The recovery from the COVID-19 pandemic will be shallow and highly exclusive if the financing needs of MSMEs, which the pandemic has hit especially hard, are not addressed appropriately. MSMEs’ fundamental importance in economic and social welfare cannot be overemphasised. They are a critical component both of well-functioning domestic marketplaces and of external trade. In Asia, they comprise over 95% of firms, accounting for 30-60% of output, and providing 50-70% of employment (Yoshino and Taghizadeh-Hesary, 2018). Beyond their economic contribution, MSMEs are also immensely important in maintaining and strengthening the domestic supply chains. Ensuring that they flourish is a critical factor in bolstering the social fabric of an economy.

Banks are the primary source of formal credit of MSMEs in Emerging Asia, and few of them have access to equity and bond markets. Since banks generally see MSMEs as riskier clients, however, many of them are unable to obtain the loans that they need. Channelling funds into MSMEs to help them meet their needs has, therefore, long been an important public policy issue. Even before the COVID-19 pandemic, financing for MSMEs was a challenge in many countries, including those in Emerging Asia, even though some governments were already providing support. Such measures include mandated credit programmes in countries like Indonesia and the Philippines.

With the global economy and international trading conditions facing considerable uncertainties, banking sectors have become more risk-averse, and some of the services they provide have become more costly.3 In the recent period of tighter credit conditions, smaller firms appear to have been affected disproportionately compared to the larger ones. The findings of Kim et al. (2021) indicate that while small and medium enterprises account for only around 23% of the demand for trade finance at the banks featured in the survey, they account for 40% of trade-finance rejections.

Emerging Asian economies have implemented a mixture of monetary policies to keep the system as liquid and accommodative as possible, and to avert a significant loss in market confidence. These policies include, among others, direct lending and forbearance, loan guarantees, loan reclassification and restructuring, and adjustments to interest rates and reserve requirements.4 Taken together, these measures exert a downward pressure on the already-low cost of borrowing.

As things stand, the policy interest rates of many Emerging Asian economies are at multiple-year, if not historic, lows. In India, the prevailing central-bank repurchase agreement, or repo, rate of 4% is the lowest in over two decades. Bank Indonesia’s seven-day reverse repo rate of 3.5%, which it adopted as its key rate in August 2016, is at its lowest since the publicly available time series was first released in June 2015. The same can be said of Bank Negara Malaysia’s overnight policy rate (1.75%), Bangko Sentral ng Pilipinas’s overnight reverse repurchase rate (2%), and Bank of Thailand’s policy rate or 1-day bilateral repurchase rate (0.5%), all of which are at record lows since the respective data series based on the current definitions were published in April 2004, June 2016, and May 20005 (see Chapter 1).

The natural rate of interest is a key variable for analysing debt dynamics and the sustainability of sovereign debt. For instance, a lower natural rate of interest may also imply lower potential growth, as many of the factors that affect the natural rate of interest also influence potential growth. Lower potential growth is likely to weigh on governments’ ability to deal with rising debt stocks. In theory, it is the real (inflation-adjusted) interest rate that would prevail when actual output equals potential output (Borio, Disyatat and Rungcharoenkitkul, 2019). Meanwhile, the drivers of the natural interest rate can include demographic profiles, productivity, the extent of risk aversion, efficiency of financial intermediation, and investment-specific technology (Brand, Bielecki and Penalver, 2018; Sudo, Okazaki and Takizuka, 2018).

Despite the challenges inherent in measuring them, there seems to be a consensus that natural interest rates are trending downwards in developed and developing economies alike (see Box 3.4). Emerging Asian economies are no exception, although there are also cases in the region where the trend is on the rise. As Figure 3.7 shows, every one of the five Emerging Asian economies selected for the sample experienced a decline in their real natural rate of interest over the period under analysis. This finding concurs with the results of previous analyses, which showed a decline in the natural interest rate in Emerging Asian countries (Zhu, 2016; Maybank, 2018). This decline was already in progress for these countries in the early 1990s, but then the Asian financial crisis halted the trend (Tanaka, Ibrahim, Brekelmans, 2021). During the crisis, Thailand, Indonesia, Malaysia and the Philippines experienced sharper spikes in natural interest rates, reflecting how deeply the crisis affected their economies. Following the crisis, the decline in natural real interest rates resumed at the start of the 2000s in all countries in the sample. In Singapore and Thailand, the trend turned in an upward direction once again from 2013 onwards, after a tightening of monetary policy in the United States. In Indonesia and Malaysia, meanwhile, the real natural interest rate appears to have stabilised since the global financial crisis.

Overall, the Southeast Asian countries, especially Singapore and Thailand, show a similar overall trend with regard to real natural rates of interest to that of the United States. Still, all of them display idiosyncrasies that cannot purely be associated with shifts in the US interest rate. For instance, in the Southeast Asian countries, the shock of the Asian financial crisis had a much larger impact on the natural rate of interest than in the United States. In addition, while the natural rate of interest remained stable after 2010 in the United States, there were slight increases in some Southeast Asian countries after 2013.

In the current fiscal and monetary environments as described above, policy makers in Emerging Asia should consider a range of options for managing public debt. In this regard, this chapter discusses various options for managing the current stock of debt, including multilateral initiatives, swap arrangements, debt buybacks, and debt cancellations and write-downs.

As governments may need to take continuous supportive measures in 2022, this chapter also reviews a range of financing sources. These include capital market solutions, such as Environmental, Social and Governance (ESG)-themed bonds, and innovative tools such as insurance-linked securities. This chapter also emphasises how regional co-operation could play in bringing the various financing options fully into operation, through means such as regional risk pools.

With the encouragement of the International Monetary Fund and the World Bank, the Group of Twenty (G20) countries launched the Debt Service Suspension Initiative (DSSI), which aims to lessen the debt burden of low-income and least-developed countries, as they recover from the impact of the COVID-19 pandemic. The DSSI suspends debt service payments (both principal and interest), and provides emergency relief for 73 eligible countries (World Bank, 2021c). In Emerging Asia, Cambodia, Lao PDR and Myanmar are eligible for the DSSI, although only Myanmar is currently participating as of 5 November 2021 (World Bank, 2021c). Cambodia and Myanmar are classified as low-risk countries both for external and overall debt distress. By contrast, Lao PDR is classified as high-risk on both metrics. Myanmar’s participation stands to save the country about USD 379.9 million (0.6% of GDP) from May-December 2020, and USD 793.7 million (1.0% of GDP) from January-December 2021 (World Bank, 2021c).

The DSSI comes with a number of conditions, the purpose of which is to balance the needs of debtors with the needs and rights of creditors. The conditions require that savings be channelled into social, health, or economic spending, for the purposes of navigating the COVID-19 crisis. Under the terms of the initiative, debt restructuring must also be neutral in net present value (NPV), and countries must not take on new non-concessional debt while still participating in the initiative.6 The NPV neutrality is a critical feature of the programme, serving to mitigate moral hazard. The repayment period is five years, with a one-year grace period for a maximum term of six years. All the Paris Club creditors have agreed to these conditions, and the IMF and World Bank also strongly encourage other creditors to adopt similar terms, whether the debt is sovereign or private.

Depending on the national context, swap agreements can also be used in renegotiating the terms of debt. In the process of renegotiation, payments can be earmarked for a particular objective. The debt-for-policy swap is an umbrella term for a type of financial swap where a sovereign issuer accepts debt relief in exchange for participation in a mandated policy action. Under such a scheme, the creditor buys the debt of a participating debtor country in exchange for a commitment to channel payments directly into achieving policy goals selected by the creditor. This is instead of directing the payments into servicing debt. Debt-for-environment swaps (also called “debt-for-climate” swaps) are perhaps the most common instruments of this kind.

Debt-for-climate swaps have the potential to provide debt relief for Emerging Asian economies while simultaneously promoting projects and policies to advance climate change mitigation or disaster prevention goals. These may be particularly useful for Asian island nations which are some of the most exposed to climate and natural disaster risks worldwide. This approach would not be entirely novel to Emerging Asia. For instance, the United States Tropical Forest and Coral Reef Conservation Act (TFCA) is a “debt-for-nature” swap that allows eligible countries to redirect payments of concessional debt owed to the United States to approved grant-making programmes if they meet certain economic and political criteria. From 1998 to 2020, USD 233.4 million were used to restructure loan agreements in 14 countries, providing USD 339.4 million to 20 projects. TFCA agreements saved more than 67 million acres of tropical forest over this period including in the Philippines and Indonesia (Nature, 2020). Cassimon, Essers and Renard (2009) find that a series of debt-for-education swaps between Germany and Indonesia in the 2000s did not open much fiscal space for Indonesia, but the earmarking required in the agreement may have contributed to the construction and equipment of 511 learning resource centres for advanced teacher training (teacher upskilling), and the construction of 100 junior high schools in the eastern provinces. Notably, these objectives were not unilaterally imposed by Germany, but rather consistent with education goals of the Indonesian government at that time. The desires of the country receiving relief must be taken into account in any of these arrangements; therefore setting up debt-for-policy swaps may be difficult in countries with weaker medium- or long-term sectoral plans.

Debt-for-equity swaps are another variation on this arrangement, and they are utilised in both the public and private sectors. In this type of deal, a share in a public or private company is exchanged for an equivalent amount of debt. This provides a mutual benefit, both to the debtor (debt-relief and investments), and also to the creditors (partial recovery of debt beyond what would be expected otherwise) (World Bank, 1993).

In the same way, a debt buyback, wherein debtors offer a lump-sum payment in exchange for the cancellation of the remainder of the outstanding debt, can also be an option for some countries. Creditors are more likely to accept these terms when it appears that the lump-sum payment is the best possible outcome for them with respect to the debt in question.

Diwan and Spiegel (1991) examine this approach to debt management, by exploring its implementation in the Philippines in 1989. In September of that year, the Philippines reached an agreement with creditors whereby the government would purchase USD 1.3 billion in debt at the rate of 50 cents per dollar, and banks would provide USD 715 million in new money at a rate 0.675% above the London Interbank Offered Rate (LIBOR), with a 15-year maturity and 7.5 years of grace (total duration of 22.5 years). The new money was disbursed in three tranches, and the buyback was executed on 3 January 1990, with the Philippines ultimately paying a net price of 24 cents on the dollar (Diwan and Spiegel, 1991).

Stiglitz and Rashid (2020) suggest that voluntary buybacks could provide savings for governments if the debt to be bought back is trading at a discount. “‘Agree[ments] to spend the savings on creating and promoting global public goods’, [such as] public health expenditures and climate change mitigation and adaptation (but not loss-and-damage)” will create future climate financing space at the expense of present reserves.

Under extreme conditions, and when it becomes apparent both to debtors and creditors that a full and timely repayment of debt is highly unlikely (e.g. Haiti’s earthquake), the parties involved may conclude agreements to cancel and write down debt.

Although debt cancellations and write-downs could provide some relief to governments struggling to manage their stock of debt, recourse to these options is currently not considered in the Emerging Asia region. This is due to the fact that these options may have some harmful long-term effects. Debt cancellations and write-downs present potential moral hazards. Governments may engage in more profligate spending and debt accumulation in anticipation of some of the debt being cancelled or written down, or they may respond to a successful negotiation of a debt cancellation or write-down by assuming more debt in the space opened by the cancellation or write-down. As such, debt cancellations and write-downs must be an absolute last resort available only in cases of clearly-defined emergencies and be accompanied by strict legislative prohibitions against taking on new debt for a period of time with similarly extremely narrow and clearly-defined exceptions.

As with debt cancellations, elaborating the terms of a debt write-down can be a protracted and costly endeavour if it requires the conclusion of several individual bilateral arrangements. The development of common term sheets to which parties agree through a joint initiative can reduce administrative costs for debtors, and may allow creditors to start accessing repayments more quickly (UNESCAP, 2020).

Examples of debt cancellations or write-downs by Paris Club creditors include three-year payment deferrals for Honduras and Nicaragua after Hurricane Mitch in 1998, one-year payment deferrals for Sri Lanka and Indonesia after the Indian Ocean tsunami in 2004, and a three-year deferral of payments for Liberia in 2008 amid significant long-term political upheaval in the country (Club de Paris, n.d.). While the debt stocks were not reduced, creditors absorbed a loss in terms of net present value by accepting deferred payments.

Prevailing conditions present significant opportunities for policy makers. First, there is an opportunity to increase the efficiency of how the financial resources that are available in the system are put to use. Second, there is an opportunity to harness other financing modalities in order to facilitate recovery from the pandemic. Against this backdrop, this section discusses the financing options for the public and private sectors in Emerging Asia, with the aim of laying a robust foundation for a sustainable and equitable economic recovery.

In particular, this section examines four key topics. The first of these is the viability of themed bonds, or of bonds that are in accordance with environmental, social and governance (ESG) principles. The second key area of focus is to look at considerations for issuing offshore bonds. The third key area to examine is the role that multilateral institutions can play in harnessing innovative tools. A fourth key area to look at, meanwhile, is ex-ante financial measures and, in particular, insurance-linked securities.

Given the significant differences between Emerging Asian countries, however, it is important to underline that certain options that are viable for one country may not be viable for another, or may simply not be appropriate at present. Similarly, financing needs and challenges can vary depending on what the money is needed for, and in which sector. Needs may also vary depending on the level of development of financial markets, including the infrastructure of these markets in the country in question. The preparedness of regulatory architecture to accommodate different types of market participants on both the demand side and the supply side also matters.7

Issuing debt securities as interest rates hit rock bottom is a reasonable option as governments seek to fund their recovery from the COVID-19 pandemic. Nevertheless, considering the other pressing challenges at present, and in particular those that relate to climate change, it is important to tailor financing in a manner that takes ESG factors into account. Indeed, sustainable finance has arguably become a premium investment class in recent years. Moreover, the fixed income securities market is a critical space in the drive towards sustainable finance, and there is growing momentum for this market to develop in the direction of ESG-themed debt securities.

In this respect, two key areas require discussion. The first of these is green bonds, and the barriers to overcome in order to develop this market. Then there is the question of social and sustainability bonds, either those relating specifically to managing the COVID-19 pandemic, or to other social outcomes.

One potential upside of bond and security instruments that are in line with ESG principles is that they help guide how the funding is used. Green bonds that focus on environmentally responsible projects are used widely, and are one of the most promising financial instruments for financing the transition to a low-carbon economy (OECD, 2017). Another advantage of green bonds is their feature to spread the cost of funding the mitigation of climate change across several human generations. This characteristic makes green bonds particularly suitable for raising funding for green investments, both public and private (Sachs, 2015; Monasterolo and Raberto, 2018). Green bonds are also a good option for attracting a broad spectrum of institutional investors (OECD, 2017).

Due to their explicit link with tangible policies, green bonds may also represent a way for governments in Emerging Asia to increase the credibility of their sustainability objectives. In combination with the attractive risk-return profile of green bonds from the perspective of investors, these factors strengthen the argument for further broadening and diversifying the investor base by opening up the market to new types of institutional investors, as well as to retail investors. Depending on what the proceeds are to be used for, several types of green bonds exist on the market, including standard green bonds, green revenue bonds, green project bonds, green securitised bonds, and green certificates. The characteristics of these instruments are summarised in Box 3.5, and will be discussed in detail in the paragraphs below.

In terms of market size, data as of the third quarter of 2021 show that the combined value of outstanding green, social, and sustainability bonds in the seven economies in Emerging Asian for which data are available is more than USD 225 billion (Figure 3.8), which is still fairly small. In 2020, these bonds accounted for nearly 0.9% of the total for all outstanding bonds (i.e. local and foreign currency bonds). Nevertheless, the debt stock has grown at an encouraging pace of about 24% annually in compounded annual growth terms between 2018 and the first three quarters of 2021, even when pandemic bonds are excluded. China still accounts for the highest share in outstanding bonds, but the other economies in the region are gradually catching up.

With regard to the currency profile of these assets, while over 70% of outstanding green bonds in ASEAN are denominated in the local currency, social and sustainability bonds are mostly denominated in foreign currency (ADB, n.d.). However, local currency issuances are expected to expand further in the coming years, as domestic markets for these themed bonds develop. The interest in these instruments in Islamic financial markets (e.g. Indonesia and Malaysia) is also likely to result in more local currency issuances.

Setting out clear parameters for the classification of green bonds, and establishing a credible system of certification, are critical elements in erecting a robust architecture for the ESG financial market to build upon. In this regard, the current debate revolves around the complexity of the existing evaluation process. This is especially the case for green bonds. Meanwhile, the appropriateness and clarity of national regulatory frameworks are also important considerations.

The issuance of a green bond involves a series of specific steps, and is more complex compared to plain-vanilla bonds. As a result, the entire process requires staff with knowledge of climate-related issues and environmental accounting and communication processes. Among other recommendations, the International Capital Markets Association’s (ICMA) Green Bond Principles encourage green bond issuers to seek out external reviews in order to evaluate both the alignment of green bonds with the Principles themselves, and to make a qualitative assessment of the overall “greenness” of the bonds. These reviews can in themselves be complicated and lengthy. The salient features of Green Bond Principles are explained in Box 3.6.

Most developing economies, including those in Emerging Asia, lack a dedicated legal framework for the issuance of green bonds (ADB, 2018b). This means that they lack clear definitions, that there is a risk of “greenwashing”, and also that they lack a common framework for the classification of green bonds. This lack of an adequate over-arching framework tends, in turn, to curtail the supply of green bonds, while also fuelling investors’ apprehensions. As pointed out by Shishlov et al. (2016), one of the major challenges for the green bond market is guaranteeing its environmental integrity in order to tackle the greenwashing risks that could hamper its success. Investors are fully aware of the existence of a greenwashing risk. An investor survey carried out by the Climate Bonds Initiative showed that green credentials and transparency on the part of issuers are the most important factors for green bond investors making investment decisions (CBI, 2019).

Nevertheless, there are a number of reasons to be optimistic for the future as far as market infrastructure is concerned. As mentioned above, groups such as ICMA and CBI have put together voluntary guidelines. ICMA has separate guidelines for green, social, sustainability and sustainability-linked bonds that also cover traditional and sukuk bonds. Meanwhile, the CBI has developed its own standard for the certification of green bonds.

Apart from these two umbrella groups, government institutions in countries including China, India, Indonesia, Malaysia, the Philippines, and Thailand have started developing their own frameworks and guidelines, although the scope and depth of these do vary. In 2015, China published a set of guidelines on green bonds, as well as a catalogue of endorsed projects (Yu, 2016; WRI, 2016). For its part, India released an official set of requirements for green bonds in 2016, closely mirroring the general architecture of the Green Bond Principles (SEBI, 2017). In addition, Indonesia rolled out a framework on green bonds and sukuks in 2018 (Government of Indonesia, 2021). Malaysia published a framework for “sustainable and responsible” sukuks in 2014 (Government of Malaysia, 2019). Furthermore, the Philippines released a set of guidelines on issuing green bonds in line with ASEAN’s Green Bonds Standards in 2018 (Government of the Philippines, 2018). Even more recently, Thailand published a sustainable financing framework in 2020 (Government of Thailand, 2020).

Multilateral organisations have also adopted green bond guidelines, and established various taskforces and working groups for greening the financial system. Examples of such initiatives include the joint roadmap for a sustainable financial system from the United Nations and the World Bank (UN Environment and World Bank, 2017), and also the work of the Taskforce for Climate-related Financial Disclosures (TCFD, 2017). At the same time, ASEAN is developing a common taxonomy for sustainable finance, which will provide the bloc with a common language in this domain, while also complementing initiatives at the national level (ASEAN, 2021).

In addition to the regional approaches, developing frameworks that are coherent at the global level could yield various benefits. Indeed, a global taxonomy could attract institutional investors and reduce the cost of cross-border capital flow transactions. An important initiative in this respect is the G20 Sustainable Finance Working Group (hereafter “SFWG”), established by the G20 member countries.8 In 2021, the SFWG has been tasked with developing a multi-year G20 Sustainable Finance Roadmap (hereafter “Roadmap”), which identifies the G20’s priorities in the area of sustainable finance. The Roadmap also sets out the work to be carried out by the SFWG on three specific priority areas: improving the comparability and interoperability of approaches to align investments to sustainability goals; overcoming information challenges by improving sustainability reporting and disclosure; and enhancing the role of International Financial Institutions in supporting the goals of the Paris Agreement and 2030 Agenda (SFWG, 2021).

Demand for green bonds tends to outweigh supply. Furthermore, leading issuers such as the World Bank and the European Investment Bank have so far carried out part of their issuance through private placements, a type of transaction that does not bring any real additional liquidity to the market. A generalisation of public green bond issuances, however, could achieve this kind of desirable liquidity.

In Emerging Asia, the supply of sovereign green bonds is relatively sparse outside the core markets of China and India. In ASEAN, meanwhile, only Indonesia and Thailand have so far issued sovereign green bonds. Indonesia is leading the way, with four green bond and sukuk issuances between 2018 and 2020, for a total of USD 2.8 billion (Table 3.4). Meanwhile, the Thai government issued the country’s first sovereign sustainability bond in August 2020. It was for USD 2.06 billion, and the government allocated the proceeds to transport and land use. Relative to domestic GDP, however, the amounts that Indonesia and Thailand have issued do appear very low. In Indonesia, each issuance was below 0.5% of GDP, while Thailand’s issuance was equivalent to 1.82% of GDP. These low levels show that there is significant potential for stepping up sovereign issuance in these two countries alone.

For any investment product, the risk-return ratio remains the first criterion of choice for investors. Thus, the profile of the issuer is a critical factor for investors. This is also true for green bonds, most of which continue to be issued by entities with elevated credit ratings, such as the World Bank. This reasoning is all the more true as prudential rules, such as the internationally-applied Basel III measures, have a tendency to get stricter. In turn, these strict regulations have the effect of encouraging investments in the least risky assets.

Investing in green bonds presents a range of specific risks for investors, such as reputational risk if the project that the bonds are financing fails to meet its stated green objectives. This risk notwithstanding, investors with reasonable doubts that a bond will actually meet the required environmental expectations only have limited opportunities for legal enforcement of the asset’s green integrity. Looking ahead, investors’ confidence may increase if they can seek penalties if the bonds fail to achieve the anticipated impacts.

In order to develop sustainable finance, it is important to address barriers both for issuers and investors. In particular, a broad pool of investors is crucial to ensuring the successful development of sovereign green bond markets, and to make sure yields respond accurately to fundamentals. The following sub-section of this chapter seeks to bring several options to the attention of policy makers in Emerging Asia. Table 3.5 summarises these options, both on the supply side and on the demand side.

In order to reduce the cost of external reviews and streamline the reporting process, governments in Emerging Asia should take advantage of the support they can get from organisations and experts such as development banks, structuring advisors, and stock exchanges. In particular, public development banks could play a multifaceted role in the green, social and sustainability bond market. For instance, public development banks have the potential to mobilise private investors by issuing guarantees or by providing first loss tranches to enhance the risk/return profiles of projects in developing economies. In addition, public development banks can provide technical support to prepare sovereign issuances (OECD, 2021e).

As an example from Emerging Asia, the ADB assisted Thailand’s government in designing and issuing the country’s first sustainability bond in 2020. The ADB has provided its technical assistance within the framework of ASEAN’s Catalytic Green Finance Facility. Its assistance includes help with external reviews, the development of internal systems to monitor the use of bond proceeds, and the preparation of post-issuance reports. Thailand’s sustainability bond raised 30 billion Thai baht (THB), or approximately USD 964 million, and was oversubscribed three times. The country’s government will use the proceeds of the bond to finance green infrastructure, namely the eastern section of the Orange Line of Bangkok’s MRT mass rapid transit system. The Thai sustainability bond will also fund social impact projects to support the country’s recovery from the COVID-19 pandemic, such as public health measures, job creation through small and medium-sized enterprises, and the development of local public infrastructure with social and environmental benefits (ADB, 2020a).

Notwithstanding the longer-term desirability of a generalisation of public issuance in order to foster liquid markets, governments could also potentially cut costs by envisaging private placements of green bonds, selling them directly to a limited number of investors. In addition to cutting costs, private placements can also speed up the issuance of a bond.

To date, private placements of green bonds have largely been used in emerging market economies as a market-development tool by multilateral development banks. However, private placements could also fulfil a niche role in the sovereign green bond market in Emerging Asia, in particular when multilateral development banks are supporting the issuance. The types of investors that may participate in private issuances, such as state-owned enterprises, mutual funds, pension funds, and other asset managers, have ample endowments, and typically turn to government securities to minimise investment risk. The Indonesian government, for example, turned to these types of investors in April 2020 when it placed debt privately in order to finance its response to the COVID-19 pandemic (Box 3.7).

The Green Bond Principles require issuers to disclose how they will use the proceeds, and to prove that all of the money will flow into green projects throughout the life of the bond. In addition, it is essential to make sure that the amount of capital raised matches up with the cost of the projects that it will finance, and that there are enough green projects in progress or in the pipeline to account for the proceeds. As such, sovereign issuers should plan in advance for how they will manage the proceeds if they do not expect to invest them immediately and there have to be safeguards to track the allocation of proceeds, and to make sure that the same eligible green project does not get listed more than once. In Malaysia and Thailand, for example, the countries’ green bond frameworks mention explicitly that they will maintain a register to record the allocation of proceeds, and that they will manage and invest any unallocated proceeds in short-term liquid instruments (Box 3.8).

In making sure that net proceeds from a green bond flow into a suitable form of allocation, an important question is whether governments should open a special account to manage the funds that they raise from green bonds. Practice differs among the ASEAN countries that have already adopted specific frameworks for sovereign green bonds (Box 3.8). In Indonesia and Thailand, the net proceeds are held in the government’s general treasury account, while in Malaysia they are transferred to the government’s development fund. Although there is currently no consensus on the best practice in this regard, setting up a special account for the management of net proceeds may streamline the allocation process and enhance investor confidence. In Fiji, for example, the economy ministry opened a designated, ring-fenced sub-account in order to store the proceeds from the issuance of green bonds (RBF, 2017).

For green sovereign bond markets to thrive in Emerging Asia, they need to attract institutional and retail investors alike. Policies aimed at diversifying and increasing the participation of both institutional and retail investors in the sovereign green bond market are, therefore, of the utmost importance for policy makers across the region.

One of the biggest bottlenecks for the development of green bond markets in the countries of Emerging Asia is the lack of an overarching framework to define and classify green bonds. In most countries across the region, the market for green bonds is generally not subject to government regulation. And in countries that lack a clear regulatory framework for green bonds, the risk of greenwashing is arguably higher.

Yet despite the limited development locally of comprehensive frameworks of this kind, the ICMA Green Bond Principles are, at the current juncture, considered to be the most widely accepted standards to promote transparency and disclosure in the green bond market, and to reduce the risk of greenwashing. Issuers of sovereign bonds in Emerging Asia need to adhere to the ICMA principles in order to enhance the integrity of the green bond market, and thus to send a signal of reassurance to investors.

Indonesia, for example, has integrated the ICMA Green Bond Principles into its framework for green bonds and sukuks. Under the terms of the framework, the proceeds of each green bond and sukuk will be used exclusively to finance or re-finance expenditure that relates directly to eligible green projects. These are defined as projects that promote the transition to a low-carbon economy and to climate-resilient growth. They must fall into at least one of the several sectors that the framework sets out (Government of Indonesia, n.d.). These include renewable energy, energy efficiency, resilience to climate change for highly vulnerable areas and sectors. They also encompass projects to reduce disaster risk, sustainable transport, and facilities that convert waste into energy. Furthermore, they also include waste management, the sustainable management of natural resources, green tourism, and sustainable buildings and agriculture.

Other examples in this respect are the various initiatives undertaken by public authorities in China and India towards ensuring clear and standardised definitions of green bonds, in line with international standards.

As mentioned above, China’s central bank published a set of guidelines for green financial bonds in 2015, including criteria for the management of proceeds, and requirements on disclosure (Yu, 2016). It also took decisive steps towards the standardisation of green bonds, by publishing a catalogue of endorsed projects (WRI, 2016). The catalogue describes the types of projects that are eligible for green bonds, and is based on Chinese environmental policies and international environmental standards. As regards the specific types of endorsed green projects, the latest version of the catalogue contains a four-level classification, which grades green projects into several categories. These encompass saving energy and protecting the environment, cleaning up industrial production and the energy sector, developing the so-called eco-environment industry, upgrading infrastructure in an environmentally sustainable manner, and green services. The 2020 catalogue contains more sectoral standards and regulations than previous editions, thus increasing the requirements for third-party verification of green bonds (CBI, 2020).

In India, there is a set of official requirements for green bonds from the country’s Securities and Exchange Board, which follows the general architecture of the Green Bond Principles, turning some of their recommendations into firm requirements. These requirements cover the definition of green bonds, plus external review, the tracking of the proceeds, and disclosure (SEBI, 2017).

In order to facilitate cross-border transactions in Emerging Asia, the standardisation of definitions for green bonds is essential, but without resorting to a heavy-handed approach. Imposing overly detailed standards has the potential to increase issuance costs, so standards should allow enough room for flexibility to respond to the different constraints that issuers may face. As noted above, there has already been some movement in Emerging Asia to create regional standards for green bonds, notably in the form of the joint statement from ASEAN’s seventh meeting of finance ministers and central bank governors, affirming that action is underway to develop a sustainable finance taxonomy (ASEAN, 2021).

More sovereign issuers in Emerging Asia could launch green bonds. In so doing, they would signal support for the market, and would contribute to its deepening by increasing the supply of green bonds in the medium term. Arguably, the issuance of sovereign green bonds could send a strong signal that governments are committed to supporting the market, by providing opportunities to invest in a broad range of projects and at relatively low yields. A deeper market would create favourable conditions for a decline in yields.

Furthermore, increasing the supply of sovereign green bonds will attract more investors. In turn, this will then also incentivise more private actors to issue green bonds. Aside from national governments, the relevant public actors that could issue green bonds are sub-national entities, such as regional or provincial governments, and municipalities. Looking ahead, public green banks (Box 3.9) are relatively new financial institutions that could also potentially play a role in expanding the offering of green bonds in Emerging Asia.

Just as national governments can issue government bonds to finance green investments in areas like clean energy or energy efficiency, cities, regions, provinces and public utilities could issue green bonds to finance investments in green public infrastructure. And since a large share of greenhouse emissions originates in cities, and with cities across Emerging Asia expected to grow further, green bonds can be a means for cities to secure funding for green investments. Aside from cities issuing green bonds directly, another option is to issue them through municipal bond agencies. Such agencies can act on behalf of several municipalities or other sub-national actors. One example of this is the Municipal Bond Agency in the United Kingdom (CIPFA, n.d.). While green bond issuance by municipalities is not new in OECD countries (Box 3.10), no cities in Emerging Asia have so far issued this type of debt.

In many countries in Emerging Asia, sub-national entities do not necessarily issue green bonds, and they could benefit from support measures from the national government in areas such as financial management and accounting practices, credit enhancements, and temporary tax incentives. The World Bank’s City Creditworthiness Initiative is one example of such efforts. Another is the various green city bond coalitions that have been emerging around the world. Such coalitions aim to build up cities’ capacity to issue green bonds, through training programmes and toolkits such as how-to-issue guides, through the provision of strategic support through development banks, through the sharing of best practices among cities’ treasuries, and also through investor awareness campaigns. In 2015, a Green City Bond Coalition was established in the United States, while similar coalitions are currently in the pipeline for India, China and Asia-Pacific (CBI, 2015).

Institutional investors may have specific constraints that can limit their investment options. According to a CBI survey of European green bond investors carried out in 2019, investors have to work within restrictions regarding currency and deal size, and these can affect their capacity to invest in green bonds (CBI, 2019). As they seek to make their offerings as attractive as possible, sovereign issuers of green bonds need to carefully balance the duration of the projects that they wish to finance with the appetite of investors. For instance, longer tenors tend to attract insurance companies and pension funds that seek to match their long-term liabilities with long-term assets.

In order to put investors’ minds at ease about the potential for reputational risk, meanwhile, one solution is to introduce penalty mechanisms into the terms of a green bond. Such penalty mechanisms could take the form of bond buyback obligations on the side of the issuer. This would mean that the issuer would repurchase its green bonds from bondholders if it does not fulfil its obligations. This could be because of a failure to achieve the desired green impact, or a loss of green ratings for the respective bond.

In addition, governments may apply tax incentives to green bonds. One example of this is exempting investors from having to pay income tax on the interest they earn on a green bond. Evidently, investors’ demand for green bonds tends to be higher in jurisdictions where such tax incentives are in place. There have been tax incentives of this kind in the United States for bonds financing renewable energy and green buildings. Tax incentives have also been proposed for green bonds in some countries in Emerging Asia, such as India and Malaysia. In India, some tax exemptions were introduced to stimulate domestic demand for green bonds and the market responded favourably. For example, the tax-free bond issued by the Indian Renewable Energy Development Agency in 2016 was more than five times oversubscribed (Agliardi and Agliardi, 2019).

Authorities in Emerging Asia could consider launching regular investor roadshows both within the region and beyond, in order to promote participation in green bond markets. The focus should be on attracting institutional and retail investors for both private and public sectors, including some public pension funds. The size of the sector is particularly large in Malaysia, where pension fund assets relative to GDP amounted to 59.9% in 2016, and also in Singapore, where they amounted to 32.2% of GDP in 2017 (Figure 3.9).

If the participation of domestic investors remains low, tapping international markets might be a more attractive option for some governments in Emerging Asia. This may allow for a further diversification of the existing investor base and open opportunities to governments to issue larger volumes at longer maturities. However, issuing bonds on international markets entails specific risks, such as foreign-exchange fluctuations, and the higher transaction costs that can stem from additional regulatory and documentation requirements.

According to a report by the Climate Bonds Initiative, local currencies have dominated the ASEAN social and sustainability bond markets to date. In 2020, the combined share of bonds denominated in local currencies stood at 60%, while issuance in hard currency (mainly US dollars) accounted for the remaining 40% (CBI, 2021). Many Emerging Asian sovereigns have a history of issuing in US dollars, most notably Singapore and Indonesia. This practice could be extended to include green bonds. For instance, sovereign issuers in the region could sell green bonds denominated in the world’s most heavily-traded currencies, in order to attract cross-border investment. Indonesia’s sovereign green bond issuance, for example, met with a positive reception from investors (Box 3.11).

Social and sustainability bonds are similar to green bonds. Social bonds finance projects that directly aim to address or mitigate a specific social issue, or seek to achieve positive social outcomes. Meanwhile, sustainability bonds refer to bonds that raise funds for undertakings that have green or social aspects. A related, but relatively new, debt instrument is the key performance indicator (KPI) bond. These bonds are target-based instruments that tend to incentivise the issuer to obtain higher ESG standards across the full gamut of its activities, as opposed to on a per-project basis. They give issuers considerable flexibility in their scope to raise capital on ESG-linked grounds (Lamdouar and Wong, 2021). However, a firm that issues KPI bonds can be penalised with a coupon step-up if it fails to achieve its targets in a given time frame. Thus, as well as the prospect of reputational risk, the firm may also lose an enforceable monetary stake.

Different kinds of ESG thematic bonds have been issued by private and sovereign entities around the world, according to needs and feasibility. Table 3.6 presents a succinct comparison of these debt options.

As shown in Figure 3.8, the outstanding value of social and sustainability bonds is still marginal by comparison with green bonds. However, available data show a rising tide of interest in these bonds in Asia following the COVID-19 outbreak in early 2020. For instance, Mehta et al. (2021) note that, in the immediate aftermath of the initial outbreak of the pandemic, green bonds were “overshadowed by social and sustainability bonds, driven by an increasing need for financing inclusive and poverty alleviation projects, as well as to meet the approaching United Nations Sustainable Development Goals (SDGs).”

Even if pandemic bonds are excluded, the average monthly issuance of social and sustainability bonds in Emerging Asian economies for which data are available rose more than fivefold from 2019 through to the third quarter of 2021, reaching nearly USD 1 billion (Figure 3.10). The outstanding amounts accordingly increased roughly fourfold, from about USD 2.2 billion in 2019, to USD 8.9 billion by end of September 2021. Among the economies of Emerging Asia, China, Malaysia, and Singapore are leading the way.

Social and sustainability bonds come in different shapes and sizes, and pandemic-oriented bonds are now increasingly a type of social bond among others, whose proceeds can finance the fight against the COVID-19 pandemic and help mitigate its economic and social repercussions. It is now very much the case that goals relating to recovery from the COVID-19 pandemic can be the underlying objectives of social and sustainability bonds. In this regard, the ICMA broadened its framework for social bonds in June 2020 to include COVID-19 themed bonds. Under the framework, the illustrative examples for eligible projects encompass three main categories. Firstly, projects can be eligible if they increase capacity and efficiency in healthcare services and the equipment that these require. The second type of project that qualifies is loans to small and medium-sized enterprises (SMEs) that support employment in small businesses that have been affected by the pandemic. The third kind of qualifying projects are those that are specifically designed to prevent or alleviate unemployment stemming from the pandemic (ICMA, 2020).

One early example was the African Development Bank’s “Fight COVID-19” social bond, which it issued in March 2020 for USD 3 billion with a three-year maturity. It was the largest social bond in the world at the time of issuance. Its proceeds will be used to alleviate the impact of the pandemic on livelihoods and economies across Africa (AfDB, 2020).

Governments in Emerging Asia have also begun to explore the potential of social bonds to finance COVID-19-related public spending. In April 2020, the Government of Indonesia issued its first pandemic bond, raising more than USD 4.3 billion. The issue included a USD 1 billion fifty-year tranche, which constitutes the longest-dated dollar-denominated debt tranche ever issued in Asia. The Indonesian government indicated that part of the proceeds would be deployed to fund its COVID-19 relief and recovery efforts, while the bulk would cover the country’s widening fiscal deficit (ADB, 2020b).

Other types of social or sustainability bonds include education bonds, health bonds and gender bonds (ADB, 2021a). As their names suggest, the proceeds of such bonds support education and health sector projects, or further the empowerment of women and gender equality. Water bonds, meanwhile, fund improvements to the quality and scope of water infrastructure.

In Asia, multilateral institutions such as the Asian Development Bank (ADB), are some of the most active issuers of these bonds. There are, however, promising signs that other stakeholders are willing to participate in this market. In the case of gender bonds, for example, a number of non-sovereign, non-multilateral issuances followed in the wake of the gender bond that the ADB issued in 2017 for 10 billion Japanese yen (JPY), and which was purchased in its entirety by Japan-based Dai-ichi Life Insurance Company. Elsewhere, Thailand-based Bank of Ayudhya issued a gender bond in 2019, which was bought by the International Finance Corporation (IFC) and the Deutsche Investitions und Entwicklungsgesellschaft (DEG) (Table 3.7). Furthermore, Indonesia-based Bank OCBC NISP, and Singapore-based Impact Investment Exchange (IIX), have also sold gender bonds.

In fact, the IIX’s Women’s Livelihood Bond (WLB) series, which was first issued in 2017, was the world’s first impact investing instrument to be listed on a stock exchange (on the Singapore Exchange). It also had the distinction of being Asia’s first multi-country listed gender bond. Following on from the success of this first issuance worth USD 8 million, IIX issued the WLB2 in January 2020, for USD 12 million, and the WLB3 in December 2020, for USD 150 million. The proceeds of these bonds are earmarked to support women-focused enterprises in India, Indonesia, Cambodia, and the Philippines in their efforts to rebuild livelihoods that have been affected by the COVID-19 pandemic.

As with green bonds, some Emerging Asian countries have already developed frameworks for social and sustainability bonds. However, the adoption of common standards like those espoused by the ICMA has been relatively slow, and the lack of a standardised set of metrics to measure their impact has led to concerns about “social washing”, or so-called “pink washing”. As is the case for green bonds, ADB (2021b) notes that many Asian sovereign and corporate issuers that would like to participate in the social bond market are currently discouraged in doing so by the lack of dedicated social bond frameworks. Understandably, it takes time, money, and skilled human resources to develop ICMA-compliant issuance procedures, and these constitute limited resources in many developing Asian economies. The due diligence requirements of ICMA-compliant securities, for instance, can be a significant hurdle for many potential issuers, thus throwing up an obstacle to participation in this market.

For the social and sustainability bond market to grow further, more issuance by sovereign and sub-sovereign entities is essential since these actors have a wider mandate to provide social services than do private institutions. Some emerging structural changes could also support long-term growth in the public sector’s issuance of social and sustainability bonds in Emerging Asia. These include aging populations, as well as increased concerns over food security and public health. As for green bonds, governments in Emerging Asia could consider getting support from multilateral organisations, such as the ADB or the World Bank, in order to streamline the issuance of social and sustainability bonds, and to lower the costs associated with the issuance.

As discussed above in the section about green bonds, social and sustainability bonds would benefit from a broadening of the investor base. However policy and strategy adjustments may be needed to attract a wide range of investors to this asset class. It is for one crucial to improve the transparency and reporting practices to mitigate apprehensions relating to “social washing”. Information campaigns can also be made more targeted. Social and sustainability bonds can be marketed as good diversification options for institutional investors. Similarly, the collective investment schemes that invest in social and sustainability bonds can be leveraged to encourage more retail investors to participate in this market.

When choosing the geographical market in which to base a bond, domestic debt issuances are typically preferred on the grounds that they mitigate risks with regard to exchange rates and liquidity. Currently, most emerging economies are still not able to tap the offshore market using their local currencies. This difficulty in accessing the offshore market using the home currency is commonly referred to as the “original sin” that affects this asset class (Eichengreen, Hausmann and Panizza, 2007).

Relatively low sovereign credit ratings, which partly determine the cost of borrowing, pose another issue in a number of Emerging Asian economies. Incidentally, the ratings of private sector firms are capped somewhat in offshore markets by the ratings of the sovereign, even if they are top-rated in the domestic market. As posited by Mohapatra, Nose and Ratha (2016), the “sovereign rating often acts as a ‘ceiling’ for the sub-sovereign ratings in most instances, although the ratings of the sub-sovereign entities have sometimes exceeded the sovereign rating”.

Nevertheless, the offshore bond market has potential to close funding gaps. This is notably a function of historic low interest rates in advanced economies, whose currencies are commonly used to denominate emerging-market foreign bonds. It is also due to the amount of liquidity that is available in the wake of aggressive monetary accommodation. Against this backdrop, there is scope for Emerging Asia’s policy makers to take advantage of the much bigger offshore investor base, which contains many investors who are keen to invest in ESG-linked instruments. In addition, ESG instruments can provide an additional dimension to the efforts to recycle the sizeable savings pool in Asia within the region.

In order to capitalise on this opportunity whilst also mitigating debt-servicing risks, Emerging Asia can bolster the capacity of the cross-country systems that are already in place. One important facility in this respect is the Multi-Currency Bond Issuance Framework (AMBIF), which the ASEAN+3 grouping (including China, Japan and Korea) put together in order to make the recycling of the region’s savings more efficient and inclusive, but without overlooking individual countries’ peculiarities (ADB, 2015). Its framework, whose implementation guidelines were first released in 2015, aims to “enable issuers in ASEAN+3 to issue bonds, notes, or sukuk (Islamic bonds) in the professional market or market segment of any participating economy in a comparable manner, using the same or similar practices and a standardised approach to disclosure” (ADB, 2020c).9 Recent published data show that there have been 12 issuances under the AMBIF, and that these are denominated in seven different local currencies.10

Together with other regional initiatives, such as the ADB’s Credit Guarantee and Investment Facility (CGIF), which dates from 2010, the AMBIF framework can be leveraged further by Emerging Asian economies in accessing the offshore market as they pursue their sustainable recovery agenda. The CGIF’s performance, in terms of its profitability and the guarantees that it has executed (CGIF, 2021), suggests substantial upsides to scaling up operations. Its coverage, which includes both sovereign and non-sovereign issuers, also makes it broadly inclusive. Thus far, 10 of the 12 aforementioned issuances under AMBIF are guaranteed by the CGIF facility.

Smaller Emerging Asian economies can also leverage strong bilateral relations in order to gain access to offshore markets, as exemplified by Lao PDR’s issuances denominated in Thai baht. The government of Lao PDR issued up to THB 46.7 billion worth of baht-denominated bonds in a variety of tenors through the Ministry of Finance from 2013 to 2018. Thailand’s relaxation of restrictions on unrated bonds, its cancellation of regulations governing the issuance of baht-denominated bonds by foreign entities, and the widespread use of the Thai baht in Lao PDR created an optimal environment for Lao PDR to issue the bonds in Thailand.

Multilateral institutions and development banks will continue to have a big role to play in helping emerging economies, both to raise funds, and to ensure the sustainability of their debt as they recover from the impact of the COVID-19 pandemic. Their assistance is particularly critical for low-income economies with very tight fiscal situations, and highly under-developed domestic capital markets.

Aside from direct commitments, there is also scope to scale up swaps for third-party liabilities in order to hedge risks related to interest and exchange rates. Products of this kind include interest rate swaps, cross-currency swaps, and local currency swaps, which transform a foreign currency liability into a local currency liability (ADB, 2020d; World Bank, 2021d).11 Aside from risk management, meanwhile, multilateral institutions can also leverage their high credit ratings to reduce the cost of borrowing for their clients, both sovereign and private.

Figure 3.11 shows a basic schematic diagram of a local currency swap arrangement, whereby the foreign currency obligation (in this case in US dollars) can be transformed into a local currency obligation, with the multilateral lending institution acting as an intermediary.12 Although it can be challenging to find counterparties to swap loans that are denominated in foreign currency (e.g. US dollar loans) for local-currency ones, there are indications that, with innovative solutions and the right mix of capital from investing institutions, it can work, and that “currency risk can be hedged even in frontier markets – at a reasonable price and with a decent return” (Giugale, 2021).

Multilateral institutions can also intermediate syndicated loans. Their role can be particularly important in securing large funding for private-sector financing in economies where domestic capital markets are still nascent (Box 3.12). On the credit supply side, they can provide market access to global banks and major global financial institutions. On the credit demand side, meanwhile, they can lower the cost of lending.

Generally, a perception of high risk raises the cost of borrowing and tends to limit long-term flows of capital to developing countries. In light of this, Gurara, Presbitero and Sarmiento (2018) contend, citing previous studies, that: “multilateral development banks (MDBs) can (i) help reduce the high risk perception by signalling the profitability of projects through allocation of their own money in projects and loan syndicates and taking a subordinate loan position and extending their de facto preferred creditor status; and (ii) leverage their informational and monitoring capacity advantages – without which private lenders would be reluctant to invest in projects that are considered to be too risky”. The authors also provide empirical evidence of MDBs’ greater willingness to fund high-risk projects that the private sector would not agree to finance, as well as of the role that they can play in reducing spreads and lengthening loan maturities.

It is impossible to rule out the recurrence of pandemics or of other similar catastrophes. Considering their potential impact, hedging the associated risks is, therefore, critically important. Insurance-linked securities (ILS), which emerged at the beginning of the 1990s, can offer insurance companies and governments some respite in challenging situations, by transferring risks to investors. In a typical ILS scheme, a reinsurance company transfers part of its risk exposure to a single-purpose vehicle (SPV). In exchange for agreeing to bear the risk, the SPV receives a premium paid by the cedant insurer/reinsurer, which is then invested in short-term, fixed-coupon bonds. The SPV then issues bonds with a maturity of less than three years, and pays a variable-rate coupon. If the underlying event, such as a natural disaster or a pandemic, does not occur, the SPV pays the coupon and returns the principal when the bond reaches maturity. On the other hand, if the event does occur, and if the pre-established trigger conditions are met, the SPV returns the principal to the re-insurer. Table 3.8 lists various ILS instruments that could be used to cope with pandemic-related risks.

Turning to further potential sources of funding, pandemic bonds are an ILS mechanism worthy of consideration in the coming years. They are similar to catastrophe bonds in structure, and are distinct from pandemic social bonds. A prominent example of pandemic bonds is the Pandemic Emergency Financing Facility (PEF) bond that raised USD 325 million when it was issued in 2017 (World Bank, 2017a). That issuance, which took place under the aegis of the World Bank’s “capital at risk” programme, was supplemented by USD 105 million in swaps, and about USD 190 million in donations (World Bank, 2017a; Jonas, 2019).

The PEF tender marked the first attempt to transfer pandemic risk in low-income countries to the financial markets. It covers six viruses that were seen as being most likely to cause a pandemic. Financing for eligible countries is activated when an outbreak reaches predetermined levels of contagion. The parameters include the number of deaths, the rate of spread of the disease, and the degree of cross-border transmission (World Bank, 2017a). The PEF mechanism is succinctly described in Figure 3.13.

The COVID-19 pandemic has recently triggered the fund to pay out. And while the mechanism has not been without its share of criticisms, the PEF Fact Sheet divulges that “by 30 September 2020, the entire USD 195.84 million COVID-19 insurance pay-out had been transferred to the beneficiary countries, providing additional financial support to their COVID-19 response, including essential and critical lifesaving medical equipment and personal protective equipment” (World Bank, 2021e).

Another relevant and related initiative is risk pooling. In this mechanism, different stakeholders contribute to a fund. The list of contributors typically includes insurance companies and, sometimes, government entities as well. Instruments like catastrophe bonds or pandemic bonds are issued in order to generate revenues. Coupon payments are then paid on a regular basis, as long as the underlying event does not occur.

One example is the Indian insurance regulator’s proposal in 2020 to create an Indian Pandemic Risk Pool (Evans, 2020). Pandemic bonds would back up this pool, and it would have a multiple-trigger mechanism, in order to respond both to epidemics and pandemics. It would cover immediate losses to income caused by business interruption resulting from a pandemic, and from the restrictions that may ensue in order to curb its spread in the first phase. Cover may not extend to losses sustained in a second phase, as the priority is to cover aspects related to business interruption, especially in the context of India’s informal labour sector (IRDAI, 2020).

Another ILS option is the mortality swap, which is an agreement to exchange one or more cash flows in the future, based on the outcome of at least one index measuring survival rates or mortality, chosen at random. Mortality swaps bear considerable similarity to re-insurance contracts, as both often involve swaps of anticipated payments for actual payments (or claims), and both may be used for similar purposes. Mortality swaps are not insurance contracts in the legal sense of the term, and therefore are not affected by some of the distinctive legal features of insurance contracts. They can typically be arranged at a lower transaction cost than a bond issue, and can be cancelled more easily. They are also more flexible, and they can be tailor-made to suit diverse circumstances.

Mortality swaps are still relatively new financial instruments. The European Investment Bank (EIB) forged such an arrangement as early as 2004, in order to assist life insurance companies and pension funds in addressing the challenges of ageing populations (Blake et al., 2006b). Although the EIB was the issuer of the proposed bond, the ultimate recipient of the longevity risk embedded in the bond was a Bermuda-based re-insurance company. The EIB undertook a swap with BNP Paribas, with the EIB receiving floating-rate funding in pounds sterling (GBP). In turn, BNP Paribas took out re-insurance for the longevity risk, retaining the interest rate exposure but with the re-insurance company insuring the longevity risk. The total value of the issuance came to GBP 540 million, and it was primarily intended for purchase by pension funds in the United Kingdom. However, pension funds and life insurers were reluctant to subscribe to this bond for various reasons, and this was withdrawn in late 2005, without ever being issued (ECB, 2006).

A further variation on this theme is extreme mortality bonds, which hedge against an insurer or re-insurer becoming insolvent. It works on the premise that a jump in mortality rates would adversely impact the amount and timing of the death benefits that an insurer or re-insurer would have to pay out. Extreme mortality bonds are short-term tradeable securities, with a pay-out structure that is explicitly linked to a mortality index. The main focus of extreme mortality bonds is pandemic outbreaks. As such, extreme mortality bonds are designed to cover the risk of mortality or the specific risk of premature death. They have similar characteristics to catastrophe bonds for natural disasters such as earthquakes or storms. Figure 3.14 illustrates the typical structure of an extreme mortality bond.

The first extreme mortality bond was issued by Swiss Re in 2003. Specifically, Swiss Re launched its first insurance-linked security relating to life insurance risk in December 2003, obtaining USD 400 million of coverage from institutional investors. The structure of the bond’s risk coverage is based on a combined mortality index. This mortality index measures annual general population mortality in five countries (i.e. France, Italy, Switzerland, the United Kingdom and the United States). It does this by applying pre-determined weights to publicly reported mortality data from each country. The principal of the bonds was at risk if, during any single calendar year in the risk-coverage period, the combined mortality index exceeded 130% of its baseline level, which corresponded to data for 2002. In exchange for their risk-taking, investors received a quarterly coupon equal to the 3-month USD London Interbank Offered Rate (LIBOR), plus an additional 135 basis points. The maturity of the bond was three years (Klein, 2006).

Another option for hedging the losses that can emanate from financially costly pandemics presents itself in the form of pandemic futures and options. In a related field, and by way of background, the emergence of markets for weather-related derivatives (i.e. weather futures and options), is a remarkable development, because these instruments target risks that are not market risks, but which, on the contrary, are relatively uncorrelated with the fluctuations of the stock market. Pandemic derivatives could be envisaged along similar lines to exchange-traded weather derivatives, which are usually linked to widely followed measures such as temperature and rainfall. Bilateral deals traded over the counter could be tailor-made for specific pandemic-related risks. Nevertheless, it is important to note also that, while the use of such instruments by insurance companies increases the scope for risk spreading, it can also present potential new risks for financial stability.

Just as there are weather-related futures and options focusing on several cities in the United States, the United Kingdom, Canada, France, Germany, Japan and Australia (CME Group, n.d.), similar tailor-made products could be designed to cover pandemic risks in Emerging Asian cities, taking advantage of the rising importance of derivatives trading in the region. According to the Futures Industry Association, Asia-Pacific accounted in 2019 for the largest volume of derivatives trading of any region in the world, with a combined share of 42% of global trading volumes (FIA, 2020). Furthermore, the volume of exchange-traded options in Asia-Pacific rose by more than 137% year-on-year in April 2021, after an increase of 114% in March (Figure 3.15).

Nevertheless, the development of derivatives markets necessitates considerable policy support. It also requires markets with sufficiently large pools of funds to cover the size of the eventual pay-outs when they are triggered. China and Singapore can provide some key lessons in terms of market development. China has five domestic derivatives exchanges, offering futures and options on agricultural products, energy, metals, chemicals, equities, and bonds. The trading volumes on these exchanges have been on an upward trajectory in recent years (Fix, 2021). Singapore, which is the largest derivatives trading centre in Emerging Asia, and one of the largest centres globally, is also a viable candidate to launch pandemic derivatives.13

Regional and international co-operation has a big role to play in enabling the region’s markets to catch up with others in terms of their absorptive capacity. Multilateralism is a critical element for increasing the mobility of funds across borders within the region, particularly when it comes to institutional investors. There is also scope, through regional co-operation, to develop mechanisms to mitigate financial risk.

Exploring potential options still further, sovereign catastrophe risk pools could provide a mechanism for Emerging Asian governments to enhance their financial preparedness against pandemic risks, by pooling risks into a single, more diversified, and less risky portfolio. Catastrophe risk pools also allow participating countries to partially retain risk through joint reserves or capital, and to transfer excess risk to the re-insurance and capital markets. Another advantageous feature of a risk pool is that profits that accrue to the pool during years with fewer disaster events can be retained within the pool, rather than being distributed to various stakeholders.

Four sovereign catastrophe risk pools exist currently, including one in Southeast Asia (Table 3.9). The four pools are the Caribbean Catastrophe Risk Insurance Facility (CCRIF), the African Risk Capacity (ARC), the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI), and the Southeast Asia Disaster Risk Insurance Facility (SEADRIF).

The SEADRIF was established in December 2018 by Cambodia, Indonesia, Lao PDR, Myanmar, Singapore and Japan, and membership is open to all ASEAN members plus China, Japan and Korea. The SEADRIF is a regional platform through which participating countries can propose, assess and implement options for managing the financial impacts of natural disasters. The first initiative within the SEADRIF framework was the establishment of a regional catastrophe risk pool, especially for flood risks in Lao PDR and Myanmar. The SEADRIF is also planning to provide financial solutions to Cambodia, and also to middle-income ASEAN countries such as Indonesia (World Bank, 2019).

Another example of financial co-operation among countries in Emerging Asia is the COVID-19 ASEAN Response Fund, which is different from the catastrophe risk pools outlined above. It was established in 2020 in order to address both the short-term and long-term needs of ASEAN member countries arising from the pandemic. The Fund will serve as a pool of financial resources to provide support to ASEAN member countries in the detection, management and prevention of COVID-19 transmission. It will be made equally accessible to all countries for, among other things, the procurement of medical supplies and equipment. The Fund will also be available to support co-operation in research and development relating to COVID-19. An initial contribution to the Fund, of 10%, came from the ASEAN Development Fund, and it then became open to voluntary contributions from ASEAN Member States and external partners (ASEAN, n.d.).

Disaster insurance schemes exist in one form or another in several developing economies in Asia. The vast majority of schemes (71%) deliver micro-insurance, while sovereign risk schemes represent approximately 14%. India, the Philippines and China are the top three countries in terms of number of operational disaster insurance schemes, and they are also among the most mature markets for disaster risk insurance across Asia (Surminski, Panda and Lambert, 2019).

In Emerging Asia, governments now have an opportunity to build on the extensive work to manage natural disaster risks that they have already done at the national level, and also on the recent experience that they have garnered through the SEADRIF initiative. In the light of this work and experience, and of the challenges of the COVID-19 pandemic, it is possible now to envisage a regional catastrophe risk pool to mitigate the impact of pandemic outbreaks. A risk pool of this kind could improve Emerging Asian countries’ resilience to pandemics, provided it is structured to accommodate the particular conditions of the region. Along these lines, it is important to bear in mind that differences in risk and economic profiles may constitute hurdles for policy makers seeking to establish a sovereign pandemic risk pool at the regional level.

In order for a regional pandemic risk pool to deliver on its promise, it will be necessary to take account of several key factors and parameters. For example, it will be important to recognise that, as the World Bank has pointed out, a regional approach for a joint disaster insurance fund would best suit smaller economies with uncorrelated but similar risk exposures (World Bank, 2017b).

A model could be envisaged whereby countries enter into an insurance contract with the over-arching facility, and pay a premium to gain access to rapid liquidity in the aftermath of a pandemic in the form of bridge financing. In addition, the risk-transfer platform could function as a clearing house for transferring pandemic risk in Emerging Asia to the international capital markets. This approach would allow large economies in the region to tap the market directly, and smaller economies to access markets as a group (World Bank, 2017b). Furthermore, and in order to avoid cross-subsidisation of premiums among countries, the premiums that each participating country would pay should have a basis in the level of risk that it brings to the regional risk pool.

The participation of sub-national entities (i.e. municipalities) in this platform could also be considered (World Bank, 2017b). For instance, a risk pool to cover municipalities against the risk of typhoons and earthquakes already operates in the Philippines (Box 3.13). Cities from multiple countries in Emerging Asia could participate in a single regional risk pool.

The COVID-19 pandemic is proving to be extremely costly, both economically and socially. It continues to test the limits of regulatory policy toolkits all around the world. Its protracted nature is depleting the resources of public and private sectors alike, which in turn curtails governments’ room for policy manoeuvre, and makes policy prioritisation more complicated. The substantial drag that it creates ultimately calls into question the fiscal stability of many countries, especially emerging economies.

Against a difficult backdrop, in which a range of other socio-economic risks compound the impact of the COVID-19 pandemic, bringing sustainable financing solutions into the mainstream, and scaling them up, is a crucial opportunity for Emerging Asian economies as they seek to ride out the storm, and to recover in a more equitable and inclusive manner. In the spirit of setting out a comprehensive array of policy options, this chapter has highlighted the importance of creating a conducive setting for ESG-themed bonds, in order to bring the capital-raising activities of public and private entities more into line with key social and environmental objectives that are becoming ever more urgent around the world. Furthermore, the chapter also addressed other issues, such as the constructive role that multilateral lending institutions can play in supporting innovative financing tools.

With the pandemic hitting economies hard, multilateral institutions have been pivotal in averting serious financial difficulties in many countries. The G20’s Debt Service Suspension Initiative, for example, has provided welcome respite for many highly indebted countries. While financial tools such as debt buybacks and derivatives are also available to lessen the debt burden, they may not be viable to some countries.

Looking to the future, strengthening ex-ante measures has a vital role to play in enhancing countries’ economic resilience to future events of a similar nature to the COVID-19 pandemic. Considering the complexities of some of the hedging and reinsurance products, putting them in place will require a concerted effort from large stakeholders, as well as access to capital markets deep enough to cover the sizeable pay-outs that an adverse event may trigger. As this chapter has also argued, strengthening regional co-operation in risk pooling is increasingly important.


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← 1. According to Vandenberg (2021), “in Singapore, a debtor normally has 21 days to pay a debt, but this was extended to 6 months under a COVID-19 economic stimulus law”, while “the threshold above which a creditor could move against a delinquent debtor was raised from 15 000 Singapore dollars (SGD) to SGD 60 000”. Similarly, in India, “the threshold for initiating insolvency was raised from 100 000 Indian rupees (INR) to INR 10 million, mostly to help MSMEs”. This was implemented at the start of the pandemic but could become permanent. The Solvency and Bankruptcy Code was notably suspended for a year from March 2020.

← 2. The World Bank (2021b) also underscores the role that moratoria and temporary relief measures for borrowers have played in Asia in minimising the effects of the pandemic. Accordingly, banking sectors’ portfolios are being restructured to varying degrees across individual banking institutions and economic sectors. The World Bank report estimates that, in China, restructured loans accounted for 4% of total loans by the end of 2020, and constituted 17% of loans to MSMEs. In Indonesia, more than 31% of loans to large corporations have been restructured. Meanwhile, in Malaysia, 11% of household loans, and 17% of business loans, have been placed under repayment assistance, including 52.8% of loans in the hotel and restaurants sector.

← 3. According to Starnes et al. (2021), with COVID-19 reducing the scale of transactions, emerging market banks face increased correspondent banking relationship challenges as earnings from low-yield trade finance services get squeezed. In their survey, these authors show that 39% of the global respondents (59% in South Asia and 20% in East Asia and the Pacific) indicated some form of correspondent banking relationship stress. The underlying factors cited in the report, among others, include fewer lines of credit, increased pricing or cost, line-limit restrictions, and increased compliance requirements.

← 4. The Asian Development Bank’s COVID-19 Policy Database provides a detailed, country-by-country breakdown of actions in Emerging Asia.

← 5. The Bangko Sentral ng Pilipinas adopted the interest rate corridor in June 2016, thus resulting in a break in the time series of the policy rate. If extended backwards by roughly adjusting for the series breaks, the current rate will be the lowest since the data were compiled and reported in the mid-1980s.

← 6. For debt restructuring to be NPV-neutral, the “NPV of the new debt service cashflows after the moratorium will be equal to the NPV of the suspended debt service cashflows” (Hernández, Egesa, and Pérez, 2020). Concessional debt is defined by the World Bank as loans with a grant element of 25% or more (World Bank, n.d. b).

← 7. In many cases, relatively smaller borrowers, as well as smaller or retail investors, are constrained from participating in traditional formal capital market channels. Some institutional investors, including public pension institutions, also face charter-related limitations that affect their ability to diversify their investment portfolio (see, for instance, OECD 2021f).

← 8. The members of the G20 are: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United States, and the European Union.

← 9. The ASEAN+3 is composed of the ASEAN economies, plus China, Japan, and Korea. The country implementation guidelines are published on the website of AsianBondsOnline,

← 10. For the data, please refer to the ASEAN+3 Multi-Currency Bond Issuance Framework Bond Issuance page at AsianBondsOnline, (accessed November 2021).

← 11. These examples are not exhaustive.

← 12. For reference, ADB (2020c) also presents schematic diagrams for interest rate swaps and cross currency swaps.

← 13. According to the Bank for International Settlements’ Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets, Singapore ranked seventh globally for interest rate derivatives in 2019 in terms of turnover, with a daily average turnover of USD 116 billion (BIS, 2019).

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