China’s bond market
Debt issuance booms despite a wave of defaults
Nov 28th 2015 | SHANGHAI | From the print edition
1. CHINA’S domestic bond market has never been riskier. It was only last year that it suffered its first default. This year at least six companies have defaulted. The miscreants are a diverse lot, including a beverage bottler, a solar-panel maker and a cement company. As economic growth grinds lower, defaults will inevitably rise.
2. A gloomy outlook of this kind would normally lead investors to demand a premium before buying bonds. Instead, they have lapped them up, making it cheaper for China’s companies to borrow. Bond issuance has boomed this year, reaching almost 12 trillion yuan ($1.9 trillion) so far, up from the record 7.7 trillion sold in all of 2014, according to Wind Information, a data provider. This has prompted warnings that, much like the stockmarket earlier this year, China’s bond market is swelling into a bubble.
3. Banks accounted for almost all lending in China until a decade ago. Today, for every five yuan of loans companies take out, they also finance themselves with one yuan of bonds. That has made China the world’s third-biggest bond market, behind America and Japan—a development that should help shield the economy from the expensive busts to which banks are prone.
4. At the moment, though, the bond market seems to be stoking risk. For most of the past five years, yields on highly rated corporate bonds were two or three percentage points higher than on government bonds of the same maturity. This year the spread has narrowed, hitting a low in early November of just 1.3 percentage points (see chart). This implies that investors think corporate bonds have become less risky, despite the proliferation of defaults.
5. Look at individual bonds, and signs of excess are even more obvious. Vanke is China’s biggest listed property developer and, by most accounts, a well-managed company. But the Chinese property business is going through a painful retrenchment after years of overbuilding, which suggests Vanke’s bonds are not without their risks. Yet in late September they were treated as just as safe as official issuers. Vanke sold five-year bonds at a yield of 3.5%, the same as the bonds of some provincial governments at the time.
6. Despite these ominous portents, many Chinese bond analysts take a sanguine view. The increase in issuance has been exaggerated by a debt swap: local governments are on track this year to replace about 3 trillion yuan of expensive loans with cheaper bonds. The average interest rate paid on outstanding debt in China has fallen from nearly 7% last year to just over 6% this year, according to Hua Chuang Securities, making it easier for borrowers to keep up with payments.
7. Besides, with growth sluggish, the central bank will probably keep interest rates low. Shi Lei, head of fixed-income research at Ping An Securities, expects yields to come down by as much as half a percentage point over the next year. Spreads between interest rates on corporate bonds and government ones are also starting to widen again. Their compression had been spurred by the stockmarket crash in July, when much of the money that fled stocks ended up in bonds of all ratings. Chen Kang of SWS Research believes that now the stockmarket has rebounded, investors are starting to differentiate again between private and government-backed issuers.
8. Whether those government-backed issuers deserve their low yields is another question. The handful of defaults to date shows that China is willing to let some companies fail, but so far no big firms in which the central government retains a sizeable shareholding have met that fate. Instead, those that have got into trouble have been rescued, leading investors to treat their bonds as virtually risk-free. SinoSteel, a struggling miner and steel trader, is the latest test of this implicit guarantee. It had been due to repay bondholders some 2 billion yuan in October, but pushed the date back to December 16th. A default would shake investors’ faith in government-backed bonds—bringing some sobriety to a market that sorely needs it.
From the print edition: Finance and economics
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