16 September 2019
The central bank’s monetary easing measures helped boost the debt market's daily turnover. Photo: CNSA
The central bank’s monetary easing measures helped boost the debt market's daily turnover. Photo: CNSA

China’s domestic debt market disregards credit ratings

The People’s Bank of China has tried its best to undertake market reforms. However, mainland banks have yet to feel any dramatic drop in their debt costs.

Currently, the cost for wealth management products remains above 4 percent, although it is declining very slowly. Is the new market mechanism still in the middle of a run-in period? Or is the low interest rate environment in developed economies unacceptable to Chinese investors?

Meanwhile, the market meltdown in A shares this year has altered investors’ risk appetite and triggered a shift in their asset allocations. Massive capital has been flooding into the bond market, leading to a debt market boom.

Last month, the yield of 10-year government bonds dropped below 3 percent. Unfortunately, dim-sum bond investors have failed to benefit from the bull market. Offshore and onshore bond markets have diverged due to the huge volatility of the renminbi.

Investors are becoming more cautious amid fears of volatility in short-term capital costs and cost uncertainty in foreign exchange swaps. Dim sum bond issuance has cooled down significantly in the third quarter.

China’s bond market size has already surpassed 40 trillion yuan (US$6.26 trillion), and daily bond trading turnover has reached more than 400 billion yuan, accounting for 1 percent of the overall market.

Daily debt repurchases recently stood at 2 trillion yuan, compared with 1.6 trillion yuan in early August and below 1 trillion yuan at the start of the year.

The domestic bond market has witnessed improving investor sentiment after the correction in 2013. The daily market turnover has recovered steadily to 150 billion yuan in 2014 from a trough of 80 billion yuan in late 2013.

Thanks to the central bank’s monetary easing measures, the debt market has seen daily turnover rise to 400 billion yuan from 200 billion yuan previously.

The debt yield has been trending downward, however. Many have failed to differentiate between risk-free government bond and the more risky corporate bond. All bonds have fairly close yields regardless of their different credit ratings and liquidity risk premiums.

The market has been filled with various default rumors, yet little sentiment has been stirred up. Will the long-standing “rigid payment” be broken? Should we accept the pricing? Smart investors have been wary of potential credit risks.

A leading Chinese property developer has issued a five-year renminbi bond at a yield of 3.5 percent. That has astonished market participants, as the yield is close to that of risk-free sovereign debt, and even lower than that of same-maturity bond issued by the state-owned China Development Bank.

China’s wealth management products in the banking sector have started to take off since 2014, soaring to nearly 20 trillion yuan from 10 trillion yuan. It has already reached a size close to the banks’ balance sheets.

High-yield bond has become much sought after in recent months due to the slow decline in the cost of debt. However, high-yield assets are in short supply amid robust demand stemming from wealth management products and funds.

The supply shortage will gradually lead to an inversion of the capital cost and investment return, which in turn will check the growth of wealth management products. That would provide an opportunity for online finance products.

I’ve found many wealth management pop-up stores during my recent business trip to Shanghai. These stores offer various high-yield wealth management products. It’s reported that third-party financial companies have already grabbed much wealth management business from banks.

Investors should watch out for the risks involved.

This article appeared in the Hong Kong Economic Journal on Nov. 18.

Translation by Julie Zhu

[Chinese version中文版]

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General Manager, Head of Investment, Investment Management, Bank of China (Hong Kong)