Caixin View: Why Higher Bond Defaults Aren’t Necessarily Bad News for Chinese Markets
China's $10-trillion bond market, the world’s third-largest, has seen increasing numbers of corporate bond defaults this year, adding to signs of stress in the onshore fixed-income market.
As of May 21, there have been 19 defaults in the onshore market this year, a 25% year-on-year increase, while the value of bonds in default has jumped 34% to 14.6 billion yuan ($2.29 billion), according to data provider Hithink RoyalFlush Information Network Co. What’s also caught the market’s attention is that a growing number of the defaulters are publicly listed companies.
Companies who want to raise money from bond sales are hitting headwinds caused by a combination of an ongoing crackdown on shadow banking and other funding channels, government efforts to rein in leverage, and a surge in maturing bonds that require refinancing. New rules have limited the use of private share placements by listed companies, and regulators have curbed the ability of major shareholders to pledge their shares in exchange for loans. New asset management rules have also made it harder for businesses to raise funds from trust companies. Investors are also becoming more selective as concerns grow over defaults, demanding higher interest rates from weaker companies, which has led to widening spreads between government and corporate bonds.
Investors are becoming increasingly wary of buying corporate bonds. Beijing Orient Landscape & Environment Co. Ltd., a listed company with an AA+ credit rating, only managed to raise 5% of its target of 1 billion yuan in a recent bond sale. Its shares plunged on the news, forcing the company to temporarily suspend trading.
Corporate bond defaults have been extremely rare in China, partly because in the past, money has been plentiful in an environment of relatively loose liquidity and partly because policymakers are concerned that defaults could trigger instability in the financial system. The very first default on the mainland bond market was only in 2014, showing how recent this phenomenon is in China.
According to Moody's, the average annual corporate default rate from 1998 to 2017 was 2.4% for advanced economies and 3.7% for emerging economies. An unnamed regulator speaking to the Shanghai Securities News this week said that the default rate of listed companies on the Shanghai Stock Exchange was about 0.22%.
Corporate bond defaults in China tend to be concentrated in the first and final quarters of the year, according to China Central Depository & Clearing Co. data, so based on historical trends, the rush of announcements so far in 2018 may well die down until November. However, this year could be different because of the ongoing deleveraging campaign.
Some commentators argue that regulatory pressure is the key source of recent defaults, and they expect this to ease in the second half of 2018, allowing companies the breathing space to refinance and avoid defaulting. Though we agree regulatory pressure is a major factor, we see little sign that it will ease. Chinese leaders have listed containing major risks, especially financial risks, as one of their top three priorities over the next three years. Overall credit growth is also unlikely to accelerate, with the People’s Bank of China holding firm to its avowed prudent and neutral monetary policy in 2018 (see Caixin View April 27).
That said, regulators are unlikely to allow a deluge of defaults for fear of trigger panic in the markets. Recent statements indicate that more supervision over corporate bonds is likely
● the China Securities Regulatory Commission (CSRC) is reminding relevant bodies to conduct inspections, issue early warnings, and monitor and evaluate potential risks of defaults among listed companies and companies who have issued bonds on the country's stock exchanges
● the unnamed bond market regulatory official told the Shanghai Securities News that regulators are strengthening supervision and information disclosure requirements
One signal of how much policymakers are prepared to tolerate an increase in bond defaults will come in the traditionally quiet periods of the second and third quarters. Any deviation from that trend may denote greater official acceptance of credit events as a normal part of the market and a commitment by the government to follow its oft-stated intentions of allowing markets to play a greater role in the allocation of resources and breaking the implicit guarantee that has prevented the correct pricing of risk by investors.
This should be taken as a healthy sign for the long-term development for the market, although it may bring pain in the short term.
Macro & Finance
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May 27: National Bureau of Statistics (NBS) releases April data on industrial profits.
May 31: NBS releases manufacturing Purchasing Managers Index (PMI), non-manufacturing PMI, and Composite PMI Output Index for May
June 2-4: A U.S. delegation led by Commerce Secretary Wilbur Ross will visit China to continue negotiations on economic and trade issues
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