18 October 2019
The People's Bank of China still has plenty of room to cut interest rates. Photo: Bloomberg
The People's Bank of China still has plenty of room to cut interest rates. Photo: Bloomberg

China must apply global standards to open up bond market

The global bond market has stepped into the bear territory, except for a handful of markets like India and China.

That’s why many foreign investors are keen to jump into China’s bond market. Its bond market is set to play a bigger role as a financing channel as authorities have frozen initial public offerings in the wake of the recent sell-off.

The Chinese central bank still has plenty of room for cutting the interest rate. The net interest rate remains at a high level of 3.66 percent. Easing the monetary environment will lure more foreign investors into the bond market as well.

However, China’s onshore debt market is less liquid than those in developed markets. For example, the turnover rate of government bonds in the secondary market is about 0.3 to 1.9 in China, compared with 10 in the United States and 5.9 in Japan.

This means that the onshore bond market still has vast potential.

However, the credit ratings in the onshore bond market remains controversial. For example, Evergrande Property (03333.HK) has an AAA rating on the mainland, and so do Sinopec (00386.HK) and China Vanke (02202.HK). However, Standard & Poor’s has rated the bonds issued by Evergrande, SinoPec, and Vanke at B+, A+ and BBB+ respectively.

S&P later cut the rating for Evergrande’s bond from B+ to B, the rating for junk bond, as it questioned the developer’s ability to repay its 26 billion yuan (US$4.19 billion) of debt. Moody’s also reduced the rating to B2.

The Chinese property developer has launched share buybacks this month after raising 4.5 billion yuan from a share issue in early June. It has spent up to HK$4.3 billion in repurchasing shares as of July 28, and the share price has rebounded by more than 70 percent from a low of HK$3.04 on July 8.

Up to 97 percent of corporate bonds have AA to AAA ratings from China’s top three credit rating agencies. By contrast, only 1.4 percent such bonds in United States have received an AA rating.

State-owned enterprises have dominated bond issuance in the past few years. Why do they have such high credit ratings?

The relationship between the company and the government is a key criterion for the bond rating, as well as for its business, profitability and solvency. If China intends to open up its bond market, it has to reform the market in a way that it conforms with global standards.

Rescue moves won’t sustain rally

Investors are more concerned about whether the Chinese authorities could stabilize the market after posting an 8 percent tumble on July 27. Beijing does not want the stock market turmoil to ripple into the real economy, such as consumption, property and bad loans in local banks.

Financial services already represent 17.5 percent of China’s economic growth. That’s why the government is desperate to unveil market rescue measures such as injecting liquidity into brokerages and prohibiting major shareholders from selling within six months.

Tom DeMark, who predicted the bottom of the Shanghai Composite Index in 2013, said the Shanghai market could drop further to 3,200 points. The Shanghai gauge had rebounded 16 percent from its July 8 low through last Friday as the government unveiled a set of market-boosting measures.

Officials allowed more than 1,400 companies to halt trading, suspended initial public offerings and supplied China Securities Finance Corp., a state-run financing vehicle with more than US$480 billion, to intervene in the markets.

DeMark believes the intervention moves won’t be able to sustain the market rally.

“Markets bottom on bad news, not good news,” he said. “You want to have the last seller sell. We got good news at the recent low. The rally is artificial.”

This article appeared in the Hong Kong Economic Journal on July 30.

Translation by Julie Zhu

[Chinese version中文版]

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Founder and Managing Director of Pegasus Fund Managers Ltd.