Hailed as an alternative way to raise funds, China´s corporate bond market faces a potentially fatal end as its second default is looming, writes financial analyst Sara Hsu in the Diplomat. Defaults were seen as way to discipline the market, but the opposite might happen.
China’s corporate bond market is relatively underdeveloped. China’s overall corporate debt is higher than that in the United States, but only a relatively small proportion of this debt resides in corporate bonds. The ratio of corporate bonds to GDP in China is only 14 percent, which is below that of Singapore, at 31 percent, and Hong Kong, also at 31 percent. China’s corporate bond market is associated with insufficient market control: issuance of corporate bonds requires excessive administrative procedures, while bonds are subject to insufficient scrutiny by ratings agencies. This is evidenced by the fact that, while Chaori Solar’s credit rating was downgraded to CCC close to one year in advance of its default, Huatong Road’s rating agency underestimated the company’s creditworthiness until only recently when the company announced a potential default.
Compounding the problem, the current economic slowdown has reduced liquidity in the financial sector, making it more difficult to lend and borrow smoothly. When economic growth began to slow, the People’s Bank of China reduced the corporate yield spread to increase corporate borrowing. Additional yield over sovereign notes that AAA-rated companies pay to sell their bonds has declined since March 31, but it has recently widened again due to the potential Huatong Road default. In addition, weakness in the financial economy and bankruptcies of smaller firms continue to present a challenge to firms seeking to obtain loans.
How to interpret the corporate bond defaults is unclear. On the one hand, it is widely believed that corporate bond defaults discipline the market. However, the trend in defaults, with a second bond payment default coming soon after the first, may bode ill for the market’s wellbeing. The default of Chaori Solar was seen as gauging investors’ risk awareness in the corporate bond market. But a second corporate bond default just four months after the first may put investors off this still-nascent market.
Managing risks is important when doing business with China. Are you interested in more experts on risk management in China at the China Speakers Bureau? Have a look at this recent list.