The Surprise on Asian credit

The cost of protection against defaults in Asian's sovereign and corporate debt soared to record highs on Friday amid fears the financial crisis could soon spread to the region, traders said.

The widening spreads in regional credit default swaps comes as stock markets worldwide continued to tumble as investors fear a deep global recession, despite government efforts to revive frozen credit markets.

"There's a general consensus that Asia is in better shape. But that doesn't mean it won't be affected. Clearly once American consumers start to scale back and then in Europe, that's going to affect Asia," said Adil Chaudhry, head of regional credit markets for Scotiabank in Singapore.

"Even though the banks are not as extended and haven't made as many structured and other types of investments as their peers in Europe and North America, they still will obviously be affected by this," he added.

The iTRAXX Asia ex-Japan high-yield index a key measure of risk aversion for the region's "junk"-rated credit, soared by about 90 basis points to a record 890/940 bps.

The equivalent investment-grade index widened by 40-50 basis points to 318/338.

Asian CDS spreads have now widened beyond benchmark levels in Europe and the United States. In large measure analysts attributed the discrepancy to the lower liquidity in the region, which tends to magnify volatility.

Investors are also concerned about worsening finances in some countries in the region as well as instability in their financial sectors. South Korea's five-year CDS widened by 30-40 basis points to about 345 basis points, continuing to trade at record levels.

That means an investor would need to pay $345,000 annually to insure against a default in $10 million of the country's underlying debt. At the end of 2007, the cost was only $40,000.

South Korea has been particularly punished amid worries about its current account deficit and the reliance of its banks and corporate sectors on short-term external financing at a time when obtaining credit comes at a steep premium.

Risk aversion in Asia has also been particularly high due to geopolitical concerns, and to some degree, due to a lack of confidence about policy responses a decade after a financial crisis dented economies in the region, analyst said.

To some, Indonesia, hard-hit by the Asian financial crisis, is a good example.

Southeast Asia's top economy has been battered by fears that it faces a a widespread financial crisis involving both its currency and equities, a well as reduced exports of commodities such as palm oil.

"People just want to get their money out of Indonesia," said a Singapore-based fund manager. "We haven't forgotten what happened 10 years ago."