While economic growth is expected to gradually rebound in the second half of the year, corporate bond issuance is expected to increase over the coming months as risks remain broadly contained.
About 9.1 trillion yuan ($1.3 trillion) to 9.3 trillion yuan of corporate bonds are expected to be issued between July and December, compared with 7.4 trillion yuan in the first six months.
There are three main reasons for the expected rise.
First, the volume of corporate bonds maturing in the second half will jump 40% year-on-year. The need to expand existing bonds by issuing new ones is quite significant.
Second, funding demand among issuers will recover as the impact of COVID-19 resurgences subsides.
In addition, asset management regulations announced in April 2018 officially came into force at the beginning of this year. The size of non-standard financial products will contract further while market demand for standard products, such as corporate bonds, will be sustained.
Therefore, up to 4.8 trillion yuan of corporate bonds are expected to be issued in the third quarter and this number is expected to be around 4.5 trillion yuan in the fourth quarter. The strong increase compared to the first half of the year indicates that the financial sector will better support the real economy.
The bond market will be enriched with more innovative products. Earlier this year, regulators introduced technology innovation bonds and low-carbon transformation themed bonds. Technology companies and energy-intensive companies in low-carbon transformation are thus provided with more financial support.
With more products introduced, related rules and regulations will be supplemented to facilitate the issuance of innovative bonds and expand the overall market size.
With a steady recovery in China’s economic fundamentals, average corporate bond yields will rise over the next few months. But given the process of economic recovery, the range of yield increases will be limited.
More treasury bonds, local government bonds and political finance bonds will be issued in the coming months, which will ease the liquidity burdens of the market.
Externally, although the US Federal Reserve has accelerated interest rate hikes, inflation levels are still high in the US. The Fed will therefore continue to raise interest rates, which will result in the inversion of Sino-US bond spreads. This will help bottom out yields in the Chinese bond market.
At the end of the second quarter, the credit spread between AAA and AA bonds was between the historical quartile and the median, and the same is true for that between AA+ and AA bonds.
Given the large number of corporate bonds maturing in the second half of the year and the expected recovery in the size of bond issues, the problem of the shortage of investable assets in the Chinese capital market will be solved. The credit spread between bonds of different ratings will continue to widen.
Against the backdrop of a gradual recovery in the Chinese macro economy and a marginal easing of market liquidity, credit risks in the Chinese bond market are generally manageable. The default rate should be between 0.4% and 0.5%, which will be equal to the level of 2021, if not slightly lower.
But given the relatively longer time needed for market entities to resume activity, the ability of issuers to improve their profitability will be disparate, especially if we take into account their current performance.
In this sense, investors should pay particular attention to companies whose profitability prospects are weakening as debt pressure increases. These less competitive companies may have difficulty making coupon or principal payments.
Real estate developers must also be closely monitored. Due to the resurgence of COVID-19 cases and lower buyer market expectations, real estate developers could face pressure on short-term capital.
Meanwhile, corporate capital expenditure for low-carbon processing will increase as China moves to become greener. The credit ratings of companies that generate high carbon emissions will be affected.
Restrictions on local government finance vehicles (LGFVs) have recently been moderately relaxed, mainly benefiting infrastructure investments with LGFVs. But it should be noted that the stranglehold of central regulators on debt management remains tight. Issues affecting the LGFV should always be considered.
Corporate bond issuance was held back by epidemic disruptions in the first half. About 7.3 trillion yuan of corporate bonds were issued in the first six months, down 6 percent year on year. Net corporate bond funding hit its lowest level since 2019 in the second quarter at 250 billion yuan, mainly due to the resurgence of COVID-19 cases in different parts of China. The economic recovery was impacted and demand for financing from the real economy remained sluggish.
In terms of capital flows, corporate bonds saw a net inflow of 10 billion yuan in the first half, which can be seen as a positive signal when compared to outflows of 80 billion yuan during the same period of 2021.
Innovative products highlighted bond issues in the first half. Of the 150 billion yuan of new bonds issued in the first six months, more than 30% were carbon neutral themed. Rural revitalization-themed bonds were the second-largest share in terms of new bonds, with 42 billion yuan of such bonds issued in the first half. While the Technology Innovation Bonds were officially issued in May, up to 36 billion yuan of such bonds had been issued by the end of June.
Going forward, China’s economic growth rate will accelerate as stabilization policies introduced earlier this year take effect and epidemic resurgences are effectively contained. But it should also be noted that the downward economic pressure is also building. The demand for financing naturally emanating from the sector of the real economy is thus weakened.
In this sense, a looser credit environment can be anticipated in the coming months.
Yi Gang, governor of the People’s Bank of China, the country’s central bank, said in an interview in late June that follow-up monetary policies will focus on the overall amount needed to support economic recovery. Additional efforts will be made in the second half of the year to strengthen the implementation of stabilization policies. Market liquidity will remain reasonably abundant. Structural monetary tools will be adopted to favor key sectors and themes such as green development, technological advancement, water conservation infrastructure, energy supply and sustainable development of small and medium enterprises.
Thus, corporate bond issuance will be broadly stable this year, with more perceptible signs of recovery in the second half.
The author is vice chairman of China Macro-economy Forum and chairman of China Chengxin International Credit Rating Co Ltd. Opinions do not necessarily reflect those of China Daily.