S&P Global Ratings said on Wednesday that credit conditions in Asia Pacific are poised to further improve in the fourth quarter but warned that risks are more of a factor too.
In its latest quarterly report, the ratings firm identified asset repricing; China's debt overhang; conflict, political and trade risks; and a liquidity pullback as the region's top risks.
A significant correction in prices of assets such as bonds, equity and real property is likely, according to the ratings firm, which reckoned that a market overreaction to the US Federal Reserve's unwinding of quantitative easing could trigger such an event.
"Abundant liquidity and steady yields have desensitized markets to tail risks, which could shock markets if they were to occur," it opined.
"In China, while overall credit-to-GDP growth appears to be slowing, corporate debt remains high risk. Meantime, rising threats include market overreaction to geographic conflicts such as North Korean missile tests and South China Sea territorial disputes and a rise in populist or extremist movements, for example in South East Asia."
Added to that, S&P said, the risk of trade wars due to, for example, tax reform or import tariffs by the Trump administration could also shock markets.
Although S&P claims reactions to these events could easily be overblown, the firm acknowledged that the risk of conflicts - in particular uncertainty regarding North Korea - is increasing. However, the ratings agency believes that the threat of a trade war appears to be stabilising.
The trigger of a market pullback from the low-volatility, high-liquidity environment of recent years is uncertain.
"That said a liquidity withdrawal is inevitable given the near decade-long era of easy money. In such a scenario, emerging markets are particularly susceptible because of their less-developed capital markets," the ratings firm said.
"In addition, a low-probability, high-impact event could cause an abrupt adjustment in investment portfolios, volatile financing conditions, and strained funding."
Heightened refinancing needs
Such a scenario could occur, for example, in response to the pace of 'QExit', added S&P.
"Less-developed markets are vulnerable, particularly those that are more reliant on external funding. Credit spreads and currency rates would become more volatile as a result."
Compounding this risk is a heightened refinancing need.
“We expect US$1.1 trillion of rated financial and corporate debt in Asia to mature through 2022 (about 11 per cent of the sum maturing globally). Much of the debt has tight spreads and some have put options," said S&P.
"The dominance of bank lending for regional corporate borrowing helps mitigates refinancing risk. Still, a severe weakening in economic growth or credit could cause banks to tighten loan supply."