Asia funding markets feel pain, worse to come

SINGAPORE, Nov 24 (Reuters): For weeks, Asian banks and businesses have seen their borrowing costs climb as cash-strapped European banks repatriate funds and cut back on loans, knowing full well this is merely a down-payment on a long and painful shrinking of funding markets. The impact so far of the euro zone's messy debt crisis has been in the weakest points in Asia: India and South Korea, whose banks rely heavily on foreign funding; Indonesia, where foreigners hold a large chunk of high-yielding bonds; and wholesale syndicated loan markets, where borrowers are looking to raise long-term funds from risk-averse investors. Yet tell-tale signs of how much more pain is in store are there, both anecdotally in credit markets as well as in the steadily rising swap spreads, reduced volumes, higher currency forwards and heavier central bank interventions. "We're in the first innings as far as European bank deleveraging goes," said Krishna Hegde, credit strategist at Barclays Capital. European banks traditionally have been active in syndicated loans and trade finance in Asia, he said, adding "those banks which were typically buyers of assets have turned sellers." "Depending on how the European sovereign situation evolves, we could see more pressure going forward. The amount of assets that need to be worked down is potentially very large," said Hegde. With an estimated $1.6 trillion of exposure to Asia, not including lending in money markets, a full-scale retreat by banks from continental Europe could lead to a liquidity squeeze like that seen in late 2008. Access to much-sought-after dollar funding has been tight. Even relatively healthy banks, such as those in Australia, have seen costs rise as investors everywhere become reluctant to lend to any institution except at penurious rates. For instance, the cost of swapping the yen for dollars via basis swaps now hovering near the highest levels since the global financial crisis. One explanation for that sort of pressure in an otherwise extremely liquid Japanese money market is that European banks and borrowers are seeking dollar funds in markets beyond their shores, and cheaply. The 1-year dollaryen cross currency basis swaps widened to minus 77 basis points at one point last week , the widest since October 2008, and were near minus 74 basis points Thursday. The Indian rupee has been driven to record lows by worry that the volatile portfolio flows funding the economy's massive current account deficit will evaporate swiftly. Indian banks are borrowing huge amounts each day from a central bank repo window. Indonesia's central bank has offered dollars in exchange for its rupiah bonds, just to prevent a rush from its market into a safe-haven asset. So far, the pullback has not been anything as disorderly as in the last global financial crisis. True, exporters are having to pay as much as 100-200 basis points more for trade finance, a traditional stronghold of the European banks. But the money hasn't dried up, nor has there been any unusual decrease in shipping or freight activity, as was the case immediately after Lehman collapsed in 2008. Data from the Bank of Korea Wednesday showed short-term external debt fell 10% in the third quarter alone, to $138.5 billion. Most of the drop came from foreign bank branches in the country, leading analysts to suspect this is owing to deleveraging by Europe. Two of Australia's biggest banks have postponed plans to launch bond issues because the costs were too great, even though the bonds were of a type normally considered super-safe. That has fed concerns that rising funding costs could prompt the banks to nudge up rates for domestic borrowers. A borrower in Hong Kong, IFC Development -- a joint venture between blue chips Sun Hung Properties, Henderson Land Development Co and Hong Kong & China Gas Co -- initially planned on raising a HK$17 billion loan.