The Ticking Debt Bomb in China’s $18.1 Trillion Bond Market
What You Need To Know
Investors in the world’s second largest bond market are facing a reality check.
While defaults were once considered a rare occurrence in China’s bond market — with many borrowers having relied on financial support or a bailout in times of trouble — the past three years combined saw a record number of delinquencies. Defaults eased off for much of 2020 as policymakers sought to limit economic damage by the coronavirus outbreak, before picking up again at the end of the year. The risks continue in 2021, according to analysts.
After years of debt-fueled spending, Chinese companies are under increasing pressure. They are trying to cope with unsustainable levels of debt and a crackdown on unregulated lending, also known as shadow banking — all against a backdrop of substantially slower economic growth compared with earlier decades. Beijing has sought to establish a more market-led approach to risk that allows competition to weed out weaker borrowers and so-called “zombie” firms.
With Beijing pulling back some of its supportive measures introduced to offset the impact of the pandemic, signs of credit stress are returning. A series of failures among state-linked companies sent shockwaves through the market, throwing doubt on the credit risks of a group of borrowers historically considered to enjoy the implicit guarantee of the state or local governments.
Key Coverage
By The Numbers
- $18.1 trillion Total value of China's domestic bond market, the second largest after the U.S.
- 84.7 billion yuan Total value of onshore corporate bond defaults so far in 2021
- $3.7 billion Total value of offshore corporate bond defaults so far in 2021
Why It Matters
There are signs Beijing is becoming comfortable with letting borrowers default on their debt. While that might turn investors off in the short term, that’s ultimately a good thing for the market longer term as it allows weaker firms to fail. Encouraging competition and allowing investors to more accurately price risk both help improve the efficiency of the country’s debt markets.
Nonetheless, there can be some nasty surprises for investors, with defaults seeming to come out of nowhere. That’s not helped by China’s local credit rating companies which assign a top rating of AAA to the vast majority of yuan-denominated debt and have even been accused of wayward behavior. Local knowledge is proving increasingly important, particularly as an increasing number of international bondholders find themselves embroiled in the country’s murky bankruptcy procedures.
