China bond market: Liquidity and risk appetite rising

Published on 26 January 2021

A macro rebound in China has buoyed investor sentiment for China. While the government is focused on deleveraging the economy and providing localised support to assuage default concerns, which were rising last year, Jason Tan of CreditSights says that credit risk has increased amongst property developers and smaller banks.

As onshore liquidity is still supportive, and offshore liquidity via channels such as China Bond Connect is also growing, financing costs are being kept low and so investors are gathering comfort about Chinese debt in their search for yield.

Dan Barnes Welcome to Primary Markets TV on the 25th of January. I’m Dan Barnes. Joining me today is Jason Tan, Asia-Pacific financials analyst at CreditSights, and we’re going to discuss bond issuance in China. Jason, welcome to the show.

Jason Tan Hi Dan. Very nice to be here.

Dan Barnes What are the big stories for you in China fixed income at the moment?

Jason Tan I think the biggest story this year in China is that in 2020, it really did an effective job in stemming the spread of the virus infections in the country. And I think that has set a very good platform for the economy to rebound. So the big story here is that the macro rebound in China is driving confidence of investors in this climate, and it has really also buoyed sentiment for investors as well. So I would say that the big themes in China this year really is the question, is this is going to shift to more reforms this year? And if if so, liquidity, which will affect bond issuance, will not be impacted and stemming certain reforms by the policymakers.

Dan Barnes We saw some defaults last year and some concern around the default situation with some backup from the Chinese government and the local authorities as well. Where do you see credit risks being greatest in 2021?

Jason Tan Just to address the topic of defaults in China, I think it’s part of the whole marketization of the economy as well as better credit risk differentiation, I think, as the economy gets on a more firm footing, I think the government has refocussed its priorities towards deleveraging. As well as de-risking the economy, in the past decade or so, China has built up a huge level of debt and leverage, and this is causing an overhang of vibrancy of the economy. So I think that’s one. As liquidity becomes more targeted and is more calibrated into the areas of the economy that needs this juicing up, I think where the credit risk are greatest is amongst some of the weaker Chinese developers and property developers this year, as well as some of the smaller banks in China.

And we understand that these are the areas where they are facing more risk with relation to liquidity, as well as in terms of the ability to refinance their debt. So I think these are the areas that would be of more concern. One big thing for now is that onshore market conditions still remain quite supportive, so that means that liquidity channels are available for the developers as well as the small banks to refine their debt as and when they want to. But there is the risk that the onshore bond markets become less supportive as liquidity and credit easing measures are gradually rolled back, hopefully in a more orderly manner by the Chinese authorities.

Dan Barnes That’s very interesting. I was going to ask what is influencing investor demand at the moment, both onshore and offshore.

Jason Tan Once again, one is probably the macro rebound and the fact that despite a recent spike in the northern provinces, the COVID-19 situation in China is definitely under control compared to many other areas in the world, so that’s one.

Secondly is that despite the depth of the contraction during the worst of the coronavirus in China, I think policymakers have been more restrained in their easing. So what this means is that China both has the flexibility as well as the availability of policy space to ease and stimulate the economy should the need arise. As it stands, the economy is firming up, recovery trajectory is coming back. We don’t see this as a base case, but there’s this sense of comfort for investors that there is still policy space remaining.

And I think lastly, not in just onshore and offshore for Chinese issuers, I think this is one place where you still can find some yeild, and as we kick off 2021, there’s a lot of money that has to be put to work, especially in the first quarter of every year. And also this year where liquidity policies and central bank policies have been very supportive across the world. So money is looking for a home, and what better place than in Chinese bond issuance? That gets a little bit more yield than in the developed world, and once again, juxtaposed against a brighter, I would say, economic outlook as well.

Dan Barnes Absolutely. And of course, we’ve also seen with the indexing of certain Chinese bonds by Bloomberg and various others that are starting to drive up liquidity among many investors. China Bond Connect, of course, is also giving access to certain investors from offshore. So that always also seems to be contributing to the overall liquidity in the market. Do you think that’s having a positive effect as well?

Jason Tan Yeah. For one it’s definitely pushing liquidity in the markets, and I think one thing that might have flown under the radar is that this influx of foreign money into onshore bond markets is helping keep financing costs relatively lower. And this provides easier conditions for bond insurers to to refinance on shore. So this is a positive development, and I think as foreign investors come into China and become more acquainted with how the system works, how the whole fixed income set up is, I think this will definitely breed more confidence in how the Chinese system works. As we know, it’s sometimes very different from, you know, a developed market, but then it’s also a huge emerging market and there’s definitely a place for China in the index.

Dan Barnes Absolutely. And we saw a note earlier this year from Morgan Stanley suggesting that overall sovereign issuance in China might be a bit low 2020 this year. What are your expectations for net issuance volumes across both sovereign and credits this year in China?

Jason Tan I think we saw quite a bit of issuance last year and we think that this year offshore issuance from Chinese players, Chinese issuers will be more limited. I think what we do see is that number one is property developers refinancing their offshore debt. There’s quite a bit that’s coming due this year as well as the next year. The second area where we do see issuance is for the local government financing vehicles; they have quite a few reaching maturity coming up this year as well as the next. Finally, in terms of the financial space, we do see refinance needs from the banks this year, that will be quite restrained overseas expansions. Framing the whole context is that, once again, onshore liquidity has been relatively abundant and financing cost has been quite low. And I think especially in the banking space, in the financial space, we do see issuers issuing more in the onshore markets, because of just easier conditions and also friendlier investors I would say.

Dan Barnes Definitely. Jason, that’s been brilliant, thank you so much.

Jason Tan Thank you, Dan.