Asia's corporate debt market should prepare for a major re-pricing once interest rates rise, Zhu Min, deputy managing director for the International Monetary Fund (IMF) told CNBC.
The $1.2 trillion Asian corporate debt market will be particularly vulnerable when the U.S. Federal Reserve hikes rates from their record lows – a move which most analysts expect to happen in mid-2015, Min said at the body's annual meeting in Washington over the weekend.
"[The Asian corporate bond market is] more or less bigger than the U.S. junk bond market, which has never happened before," said Min.
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"Half of [investors] are international investors, and, furthermore, the investment base is very much focused on four to six big funds…So, if these funds move I think there [will be] liquidity issues," he added.
Higher U.S. interest rates are a concern for bond investors. Bond yields and prices area inversely correlated; as yields rise, prices fall.
"If you're looking at the price, the price is pretty low in Asian assets – in the bond markets and other assets – so the interest [rate] were to change obviously you will see the liquidity change, you will see re-pricing of these assets. Asia needs to be prepared for this moment," Min told CNBC.
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However, Min expects the Asian economies bruised during last year's tapering panic to better weather talk of tighter monetary policy this time round.
"The May 2013 call was sort of a warning call for macro, so… India, Indonesia, Malaysia, Thailand, all those countries got the lessons quickly fixed on exchange rates, on the fiscal deficits, on the inflation rate size… The situation from macro it's much better and current account situation is much better," he added.
Last week, global markets logged their worst trading week of the year, with the Dow wiping out its entire year-to-date gain. Meanwhile, the VIX – a widely used measure of market volatility – surged to 21.1, its highest level since February.
The major risk from monetary policy tightening in the U.S. is for financial markets, Min said.
"Now the focus is shifting to the financial market, because the financial market does have the 'over risk taking behavior' we observe," he added.
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Civil disobedience in Hong Kong
In terms of market risks, investors continue to follow developments in Hong Kong, where pro-democracy protests entered their third week.
The resilience of Hong Kong's financial markets to the political risk is encouraging, Min said.
"The good news is that markets are still functioning… it's more important that transactions [are] still going on and the bond markets… derivatives markets, settlement agreements, all the things [are] still going on," he said.
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On Japan
The IMF recently downgraded its 2014 growth forecast for Japan, the world's third largest economy, to 0.9 percent from 1.6 percent.
Min blamed the impact of the consumption tax hike in April for weak growth in Japan, but said the economy would bounce back by year-end.
"In the long term, we see the central bank of Japan continuing to do quantitative easing and the government should further push structural reform, bringing the confidence back," he said.