China bonds: higher yields are required to repay debts
Record issuance means that total liabilities have reached concerning levels for some companies
Just two years ago, foreign investors and issuers were captivated by the Chinese bond market. Falling yields across the US and Europe drove offshore funds to renminbi-denominated Chinese debt. Government bonds, including local issuance, hit a record. Now the risks are rising.
China issued more than Rmb1.5tn ($223bn) of local government bonds in June, a monthly record and up 80 per cent from the previous year. Issuance of bonds designed to fund infrastructure projects has exceeded Rmb2.5tn so far this year, triple last year’s figure. Infrastructure-related, state-owned groups such as China State Railway Group have ramped up issuance too.
Hopes that infrastructure projects would stimulate lagging economic growth helped drive the surge. Borrowers took advantage of low rates. China State Railway, for example, sold 2026 bonds last autumn at a yield of just 3.16 per cent.
That made sense when yields on 10-year US Treasuries were below 1 per cent. Now they exceed 2.9 per cent.
Meanwhile, local defaults are rising. Last year, 37 Chinese bond issuers defaulted. Of those, 12 were state-owned enterprises. Foreign investors have realised that these do not come with implicit government guarantees. Record issuance means that for some companies total liabilities have reached concerning levels. At China State Railway, they hit Rmb5.9tn last year.
Investors should take the hint from foreign issuers who slashed offerings of renminbi-denominated bonds in China this year. Issuances of panda bonds are at less than half that of last year’s average.
Beijing’s strict zero-Covid policy continues to pressure domestic demand. Reaching the country’s full-year economic growth target of around 5.5 per cent is unlikely. Economists expect gross domestic product closer to 4 per cent.
Debt sales will not stop. Slowing growth means further infrastructure investments — and more borrowing — should be expected in the coming months. Chinese issuers will have to expand the spread between US and Chinese bond yields to attract the same level of investors.