Across The Border | China’s bond market to change in second half as investors avoid risk

Issuance patterns in China’s bond market look set to change in the second half of this year as private sector debt falls and public debt increases, according to analysts.

In Moody’s Investor Services Interbank Bond Monitor published last week, Ivan Chung, a Moody’s associate managing director wrote: “We expect the growth pattern in bond issuance will begin to change in the second half of 2016. Issuance by the corporate sector will slow down despite strong growth in the first quarter of 2016. On the other hand, bond issuance by central and policy banks, as well as RLGs [regional and local governments], will likely continue.”

The change started to become apparent in the second quarter of this year. According to data compiled by Bloomberg, between April and July Chinese companies sold 1.85 trillion yuan (HK$2.15 trillion) of onshore bonds, a 30 per cent drop from the previous three months, and the sharpest quarter-on-quarter decline since September 2011.

Meanwhile, the number of public bond defaults in the first five months of 2016 exceeded the total for the entire 2015. “These incidents have prompted onshore investors to recalibrate their expectation of implicit government support for state-owned enterprises and increase their risk aversion towards overcapacity sectors,”Chung wrote.

“These changes have resulted in widening credit spreads between bonds of high and low domestic ratings and a significant rise in cancellation of new bond issuance in April.”

A widening credit spread, i.e. the difference between the yields of different kinds of bonds, would traditionally suggest that investors were more worried about defaults from riskier bonds, as higher bond yields mean lower prices.

One example of an industry where this has been seen is China’s steel sector. “Over-capacity and over-leverage remain significant challenges for the Chinese steel industry, and we believe that this will contribute to continued high credit risks in the sector following several high-profile defaults in late 2015 and early 2016,” said a commentary released last week by ratings agency Fitch.