Extend reforms to corporate bond market
LIU MINGKANG, China's top banking regulator, devoted his press conference on Monday to ways to reform the mainland's ailing state banks. It's too bad we don't hear such aggressive talk about China's capital markets.
Among policymakers in Beijing, there is a great deal of focus on the official one trillion yuan of non-performing loans in China's banking system. This is an understandable concern. But it is also important to create liquid securities markets capable of assisting in the workout of these loans and allocating capital to the more efficient sectors of the economy.
The bond market is a case in point. The government has put the emphasis on issuing high-profile global bonds or domestic bonds to soak up excess cash in the economy. But corporate bonds, which could provide fuel for the fast-growing private side of the economy, have made little headway.
It is rare to hear any discussion of capital markets and even rarer to hear an official talk about the bond market.
That's a shame. In classical financial theory, firms adjust their capital structure according to the price of equity versus bonds, reflecting interest rates, share prices, and the tax structure. Meanwhile, the corporate bond law has not been updated in a decade, and new corporate bonds have to squeeze through a minuscule and outdated quota system that makes Beijing's rush hour traffic look like an expressway.
The peak year for corporate bond issuance was 681 billion yuan in 1992. Last year, just 170 billion yuan in corporate bonds were issued. Granted, there has been a gratifying rise in the outstanding balance of corporate bonds to 133 billion yuan last year from 63 billion in 1997, but it is still relatively small change.
According to the People's Bank of China, corporate bonds are dwindling in importance, falling to 4.3 per cent of outstanding bonds last year from 6.5 per cent in 1997.
There are a number of reasons for the small size of the market.
The government has been nervous about letting the floodgates open because of high-profile scandals in the 1990s. The most famous was Guangdong International Trust & Investment Corp (Gitic), which defaulted on US$4.7 billion in debts, despite local government guarantees. Gitic had implied it was backed by Beijing, but it wasn't.
In addition, a number of companies borrowed almost US$4 billion through bonds to build a toll-road system. Unfortunately, a new petrol tax replaced many tolls, killing a key source of revenue.
More important, the People's Bank of China retains strict control over interest rates for corporate bonds, and is hesitant to allow higher interest rates, a big deterrent for investors looking for meaningful returns.
Analysts also point to other problems in the financial system, including a lack of a strong bankruptcy law and huge default risk. That explains why, in September, regulators gave permission to 15 companies to raise 32.5 billion yuan in corporate bonds. Most are listed overseas or are state-owned companies and thus are viewed as the safest credit risks.
Meanwhile, Chinese companies have access to cheap money through the over-inflated valuations of shares in the equity markets. And accounting rules allow insurance and other investors to price their bonds based on historical cost instead of marking to market, which reduces the incentive to trade.
These are legitimate issues. Regulators certainly should be applauded for being cautious. Although the stock markets are still cowboy territory, the bond markets have achieved an aura of respectability.
But if Beijing's regulators can tackle the country's one trillion yuan in non-performing loans, surely they can face a liberalisation of the minuscule 133 billion yuan corporate bond market.
China is a good credit risk. In October, Moody's Investors Service raised China's foreign-currency rating by a notch to A-2, citing the country's strong external position, solid exports and ability to attract foreign investment.
Steps should be made to cut back on the seven agencies now approving new bonds, interest rates should be liberalised, and independent credit agencies should be supported.
Regulators should let a flourishing corporate bond market offer companies and investors an alternative to the country's skittish stock markets.
