Corporate bonds to recover as prospects brighten in the latter half

As economic growth is expected to gradually rebound in the second half, the issuance of corporate bonds is likely to increase in the next few months with overall risks remaining under control.

Approximately 9.1 trillion yuan ($1.3 trillion) to 9.3 trillion yuan of corporate bonds are expected to be issued in the July-December period, up from the 7.4 trillion yuan reported in the first six months.

There are three major reasons for the expected rise.

First of all, the volume of corporate bonds facing maturity in the second half will jump 40 percent year-on-year. The need to extend existing bonds by issuing new ones is quite significant.

Second, financing demand among issuers will recover as the impact from COVID-19 resurgences subsides.

In addition, the asset management regulations announced in April 2018 officially took effect at the beginning of this year. The size of nonstandard financial products will further contract while market demand for standard products, such as corporate bonds, will be buoyed.

Therefore, up to 4.8 trillion yuan of corporate bonds are expected to be issued in the third quarter and the number is likely to be around 4.5 trillion yuan in the fourth quarter. The substantial increase compared to the first half indicates that the financial sector will better support the real economy.

The bond market will be enriched with more innovative products. Earlier this year, regulators introduced technology innovation bonds and low-carbon transformation-themed bonds. Tech companies and energyintensive companies undergoing low-carbon transformations are thus provided with more financing support.

With more products introduced, related rules and regulations will be completed to facilitate the issuance of innovative bonds and expand the overall market size.

With stable recovery of China’s economic fundamentals, average yields of corporate bonds will go up in the next few months. But given the process of economic recovery, the range of yield increases will be limited.

More treasury bonds, local government bonds and policy financial bonds will be issued in the following months, alleviating market liquidity burdens.

Externally, although the US Federal Reserve has accelerated interest rate hikes, inflationary levels are still high in the United States. The Fed will thus continue to raise interest rates, which will result in the inverted China-US bond spreads. This will help to form a bottoming out of yields in the Chinese bond market.

At the end of the second quarter, the credit spread between AAA and AA bonds was between the historical quartile and median, and the same situation holds true for that between AA+ and AA bonds.

In light of the large number of corporate bonds to mature in the second half and the expected recovery in bond issuance size, the problem of investable asset shortages in the Chinese capital market will be addressed. Credit spread between bonds of different ratings will further expand.

Amid the gradual recovery in China’s macroeconomy and the marginal loosening of market liquidity, credit risks in the Chinese bond market are controllable in general. The default rate is expected to stand between 0.4 percent and 0.5 percent, which will be on a par with the 2021 level, or even slightly lower.

But given the relatively longer time required for the recovery of business activity among market entities, issuers’ ability to improve profitability will be disparate, especially when taking into account their current performance.

In this sense, investors should pay close attention to companies whose profitability outlook is weakening while debt pressure is mounting. These less competitive companies may find difficulties making coupon or principal payments.

Property developers should also be closely watched. Due to resurgent COVID-19 cases and homebuyers’ lowered market expectations, property developers may face capital pressure in the short term.

Meanwhile, companies’ capital expenditures for low-carbon transformation will increase as China is set to go greener. Credit ratings of companies incurring high carbon emissions will be affected.

The restrictions on local government financing vehicles (LGFV) have recently been moderately relaxed, mainly benefiting infrastructure investment with LGFV. But it should be noted that the central regulators’ grip over debt management is still strict. Problems affecting LGFV should still be heeded.

The issuance of corporate bonds was held up by epidemic disruptions in the first half. About 7.3 trillion yuan of corporate bonds were issued in the first six months, down 6 percent year-on-year. Net financing of corporate bonds hit the lowest level since 2019 in the second quarter at 250 billion yuan, mainly due to resurgent COVID-19 cases in different parts of China. Economic recovery was impacted and financing demand from the real economy remained sluggish.

In terms of capital flow, corporate bonds reported a net inflow of 10 billion yuan in the first half, which can be considered a positive signal if compared to the 80 billion yuan outflow during the same period of 2021.

Innovative products highlighted bond issuances in the first half. Of the 150 billion yuan novel bonds issued in the first six months, over 30 percent were themed on carbon neutrality. Bonds themed on rural revitalization made up the second largest share in terms of novel bonds, with 42 billion yuan of such bonds issued in the first half. While technology innovation bonds were officially issued in May, up to 36 billion yuan of such bonds had been issued by the end of June.

Looking forward, China’s economic growth rate will pick up as stabilizing policies introduced earlier this year will take effect and epidemic resurgences are effectively contained.

But it should also be noted that downward economic pressure is also strengthening. Financing demand naturally arising from the real economy sector is thus weakened.

In this sense, a relaxed credit environment can be anticipated in the following months.

Yi Gang, governor of the People’s Bank of China — the nation’s central bank — said in an interview in late June that follow-up monetary policies will focus on the overall amount needed to support economic recovery. More efforts will be made in the second half to strengthen the implementation of stabilizing policies. Market liquidity will remain reasonably ample. Structural monetary tools will be adopted to favor key sectors and themes such as green development, technology advancement, water conservancy infrastructure, energy supply and the sustained development of small and medium-sized enterprises.

Therefore, the issuance of corporate bonds will be generally stable this year, with signs of recovery more noticeable in the second half.