New bond rules will go into effect in China tomorrow, and they aimed at easing risk in debt markets. The latest initiative comes none too soon. Corporate bond defaults rose in the first quarter.
China Securities Depository and Clearing Corp, which oversees promissory notes in the nation's smaller exchange-traded market, will now restrict financial institutions to using only AAA-rated company securities as collateral for short-term loans, according to a document seen by Shanghai Daily.
That move will tighten liquidity in markets for lower-rated notes and junk bonds. It will make it harder for smaller companies to issue bonds on the stock exchanges, increasing their financing costs as bond yields go up, said Gao Chen, a bond market analyst at Shanghai Securities Exchange.
Until now, securities with ratings of AA or higher were eligible to be used as collateral. The new rules won't apply to notes sold before tomorrow, according to the document.
Only 34.2 percent of total funds raised by issuing bonds involved AAA-rated debt traded on the Shanghai and Shenzhen stock exchanges, according to data compiled by Wind Information, a Chinese financial information provider.
The value of the smaller exchange-traded market is about 5.5 trillion yuan ($798 billion), compared with 58.2 trillion yuan in the interbank market.
That size differential could limit the short-term effect of the new rules, Gao said.
"The central bank made its intentions very clear on this," said Gao. "Along with its rare raising of key interest rates in March, efforts on financial deleveraging are afoot."
Leveraging is the practice of issuing debt to raise money to make other investments. Trouble arises when those investments fail to prosper enough to cover debt repayments.
Since late January, the People's Bank of China has twice raised key short-term interest rates, including the seven-day repo rate. Market participants broadly interpret the moves as an effort to push up funding costs in the interbank market and damp speculative investments.
As authorities squeeze risk from the market, the number of defaults on corporate bonds rises. In the first quarter, nine corporate bonds missed repayment obligations. That compared with 29 in the whole of 2016.
A massive number of defaults could snowball into serious problems across financial markets because investment tentacles reach into a web of interrelated segments.
Most of the recently defaulting companies were in heavy industry and construction, including Dalian Machine Tool Group Corp and Dongbei Special Steel Group Co. They ran into trouble by taking on too much debt as the nation's policies turned to reducing industrial capacity.
The government listed "deleveraging" as one of the five key supply-side reform tasks in its annual work report issued in March. Debt swaps and debt-to-equity ratios come into focus as the government pursues a "neutral" monetary policy with a tightening bias.
A solid economic start to the new year gives the government more wiggle room in tightening risk and tackling financial leverage, said Liang Hong, an analyst with China International Capital Corp.
The official manufacturing Purchasing Managers' Index stood at 51.3 in January, marking the fourth consecutive month it was above 51. A reading above 50 points to industrial expansion, and a reading below signals contraction.
The index showed particularly good resilience in the month before the Chinese New Year, when retail sales and tourism traditionally get a boost but industrial production and construction slow.
Still, many experts warn that the central bank is in a delicate balancing act between tightening policies and keeping the economy ticking along.
Brian Coulton, Fitch Ratings chief economist, told the South China Morning Post last week that it's hard for China to give up a debt-fueled growth model that has helped the nation achieve short-term economic stabilization, even at the expense of an expanding mountain of debt.
Indeed, credit growth remains strong and lending to state-owned corporations is picking up again. New bank loans in China last year hit a historic high of 12.7 trillion yuan, and momentum continued into January, with 2 trillion yuan in loans extended.
"Stabilization has been achieved by 'releveraging,'" said Coulton. "It's not a sustainable situation when the ratio of debt to gross domestic product continues to rise very rapidly, year after year."
