China's bond market: Running on demand

Ivan Chung at Moody’s Mid-Year China Conference: Understanding the Risks of High and Rising Leverage, May 31,2016.[Photo provided to chinadaily.com.cn]

China’s onshore and offshore bond market will continue to grow on back of strong demand for financing and stability of RMB’s exchange rate, says Ivan Chung, Associate Managing Director, Head - Greater China Credit Research and Analysis at Moody’s.

In an interview with China Daily website, Chung says this year will be a turning point as capital starts flowing from over-capacity industries to emerging sectors.

Here are the excerpts:

(1)How do you see both onshore and offshore RMB bond markets developing in 2016?

Onshore market

The total volume of onshore RMB bond market will continue to grow, though the speed may be not as fast as last year. The two main reasons are: strong demand from corporates for financing (including re-financing) and the rapid growth in local government bonds, including those from the debt swap program. The relatively low interest rate environment has also fueled the bond issuances as many issuers consider issuing new bonds or bonds for re-finance.

The pace of bonds’ development staying steady instead of moving at a radical speed could be because investors are wary of default risks this year. The one factor we should be paying special attention to risk in the bond pricing. As such, risk is priced more fairly in bond pricing and spread of bond yields among issuers of different risk profile widens. In the past when default barely happened and investors expected “automatic bailout” of financially distressed issuers by banks or governments, there was hardly any difference in bond pricing of different issuers. Because everyone assumed defaults would never happen, investors would naturally choose the one with highest yield. But since last year more default cases have started taking place, including State-owned enterprises (SOEs). From our observation, currently the widening yields of SOEs’ bonds issuing could well reflect the different levels of risks. So this situation may restrain many companies’ motivation to issue bonds, because of the increase in costs.

This may facilitate more efficient credit resources distribution because investors would allocate their capital based on risks.

Previously, many worried that there would be drastic fluctuations in the bond market, just like in the stock market. We don’t expect much volatility in the bond market. Our confidence is based on two points. First, the overall environment of interest rate is low, which is accommodative. Second, the default volume is small and still far from the level to trigger massive market volatility.

Up to now, the default cases have mainly happened in non-core subsidiaries of SOEs or SOEs in over-capacity industries. The central government would weigh the repercussions of the defaults on the market. If there are signs of potential systematic risks, the central government will likely step in.

This year will be a turning point as capital gradually starts flowing from over-capacity industries to the new sectors to align with the ongoing economic rebalancing. However, structural adjustment needs time to complete and it will be gradual.