A week ago we highlight the "last bubble standing" was finally bursting, and as China's corporate bond bubble deflates rapidly, it appears investors are catching on to the contagion possibilities this may involve as one analyst warns "the cost has built up in the form of corporate credit risks and bank risks for the whole economy." As Bloomberg reports, local issuers have canceled 61.9 billion yuan ($9.6 billion) of bond sales in April alone, and Standard & Poor’s is cutting its assessment of Chinese firms at a pace unseen since 2003. Simply put, the unprecedented boom in China’s $3 trillion corporate bond market is starting to unravel.
As Bloomberg notes, China’s leaders face a difficult balancing act.
On one hand, allowing troubled companies to default forces money managers to pay more attention to credit risk and accelerates government efforts to curb overcapacity.
The danger, though, is that investor panic leads to tighter credit conditions, dealing a blow to President Xi Jinping’s plan to keep the economy growing by at least 6.5 percent over the next five years.
However, as we pointed out previously, economic figures for March reveal a growing dependence on debt. China’s aggregate financing -- a broad measure of credit that includes corporate bonds - grew by over $1 trillion in Q1...
And yet even that wasn’t enough to save the seven Chinese companies that reneged on bond obligations this year. Three of those were part-owned by China’s government, seen not long ago as a provider of implicit guarantees for bondholders.
The reaction has been swift in China’s 18.8 trillion yuan corporate bond market (a figure that excludes certificates of deposit). The extra yield investors demand to hold seven-year onshore corporate bonds with top ratings over similar-maturity government notes has jumped by 28 basis points from an almost nine-year low in January, to 91 basis points as of Monday.
At least 64 Chinese firms have postponed or scrapped planned note sales this month, six times more than the same period a year earlier.
“As more and more issuers default, lenders and investors will reassess their portfolio and lending, and that will cause yields to rise,” said Christopher Lee, chief ratings officer for Greater China at Standard & Poor’s in Hong Kong. “If the onshore market has any dislocation, that will have a spillover effect in the offshore market.”
Rising defaults are actually healthy for China’s bond market, said Xia Le, the chief economist for Asia at Banco Bilbao Vizcaya Argentaria SA in Hong Kong.
“It shows the government is taking away the implicit guarantee,” Xia said. “Now risk awareness is rising, so we will see which issuers are swimming naked.”
While bond yields in China are still well below historical averages, a sustained increase in borrowing costs could threaten an economy that’s more reliant on cheap credit than ever before. The numbers suggest more pain ahead:
Listed firms’ ability to service their debt has dropped to the lowest since at least 1992, while analysts are cutting profit forecasts for Shanghai Composite Index companies by the most since the global financial crisis.
As Qiu Xinhong, a Shenzhen-based money manager at First State Cinda Fund Management Co. said...
“The spreading of credit risks is only at its early stage in China."
We leave it to Xia Le to conclude,
"The equity rout merely reflects worries about China’s economy, while a bond market crash would mean the worries have become a reality as corporate debts go unpaid," said Xia Le, the chief economist for Asia at Banco Bilbao. "A Chinese credit collapse would also likely spark a more significant selloff in emerging-market assets."
"Global investors are looking for signs of a collapse in China, which itself could increase the chances of a crash... This game can’t go on forever."