China’s bond-market mystery: Why aren’t there more defaults?
Beijing is working to maintain stability, even as it tries to tackle its key economic problem, analysts say
SHANGHAI— Beijing’s determination to tame China’s soaring debt levels has won plaudits from bullish observers who believe the government is finally tackling its key economic problem.
Why, then, has there been so little stress in the country’s bond market?
Defaults on Chinese bonds might appear to have risen sharply this year, in volume terms. A total of 13 issuers have defaulted on a combined 20.2 billion yuan ($3.1 billion U.S., $4.1 billion Canadian) worth of corporate bonds in China’s domestic market in 2018, up 41per cent from the same period last year, when 11 issuers had defaulted.
Yet default levels remain trivial at just 0.08 per cent of the total $4 trillion of corporate bonds outstanding in China. Absent a major financial crisis, the corporate-debt default rate is typically around 2 per cent globally, according to Ivan Chung, a Hong Kong-based analyst at Moody’s Investors Service.
The low default rate has participants in China’s bond market, now more open than ever before to foreign investors, wondering when the pain from Beijing’s war on debt will hit — and just how committed the government is to tackling the problem.
In an effort to lower debt levels, Beijing has raised key shortterm interest rates several times in the past year to push up borrowing costs. It has also cracked down on so-called shadow banking as well as on various forms of short-term debt issued between banks to deter speculative, leveraged bets that have amplified risk in the bond and stock markets.
China’s total debt could reach nearly 250 per cent of its gross domestic product by the end of this year, according to S&P Global Ratings, up from 170 per cent in 2012. Corporate debt accounts for just under half the total.
“The reason why the bond default rate remains quite low in China is still because of government intervention,” said Zhu Chaoping, a Shanghai-based economist at J.P. Morgan Asset Management. “The government is focused on maintaining stability, financially and socially.”
In the past, Beijing has often leaned on banks and local governments to extend a lifeline to struggling state-owned enterprises, and even private companies if they are large employers, Mr. Zhu said. The authorities have also stepped in with more sweeping action when there are broader signs of market stress, as in January when Chinese government-bond prices fell to a three-year low. The central bank cut the amount of cash it requires banks to hold with it in reserve, unleashing around 450 billion yuan of liquidity into the market.
Market participants expect the central bank to ease financial conditions further later this year, if China’s pace of economic growth slows and bond defaults pick up. However, if the authorities yield to pressure on the bond market and bail out failing companies, “they could end up concealing the risk again and kicking the can down the road,” Mr. Zhu said.
There have been some indications of heightened market nerves. Yields on five-year corporate bonds with a rating of AA-minus, the equivalent of junk bonds in China, thanks to the country’s generous creditrating system, are now 3.67 percentage points above those on corresponding Chinese government bonds, the widest gap in two years. The gap, known as the credit spread, measures the extra return that investors demand for investing in risky corporate bonds versus buying relatively safe government debt.
Part of the reason this year’s defaults have grabbed more attention is that some of the issuers — from a shoe and garment maker to a new energy equipment manufacturer — were listed companies. In previous years, nearly all the firms that failed to repay bond investors were privately held.
Among the13 issuers that have defaulted this year, four are listed companies, compared with just one out of 11 in the same period last year.
Still, “the total amount (of defaults) involved remains very small and I don’t think there’s panic in the market,” said Moody’s Mr. Chung.
The defaults that have occurred domestically this year have in part resulted from Beijing’s efforts to clamp down on shadow banking. Many companies in China, particularly in the private sector, have long had limited access to traditional bank loans, with major banks preferring to lend to stateowned companies. Instead they have relied on obtaining loans from outside the formal banking system.
The volume of trust loans, a key form of shadow banking in China, shrank year-over-year in March and April, the first such falls since November 2015.
“Some of the bond issuers were counting on these sources of funding to repay investors. Now they are left with no choice but to default,” said Wu Zhaoyin, chief strategist at AVIC Trust Co., which manages assets worth nearly 650 billion yuan.
It is not just in China’s domestic bond market where jitters are increasing. In late May, China Energy Reserve and Chemicals Group, a Beijing-based conglomerate, failed to repay investors the principal amount of a $350 million bond, the first default on dollar-denominated Chinese corporate bonds this year.
“We have been expecting rising defaults from China but that of China Energy ... came out of nowhere,” said Mark Lo, head of fixed income at AMTD Asset Management Limited in Hong Kong. “It’s time defaultrate expectations on Chinese debt get revised,” Mr. Lo added.