China's Credit Wheel Has a Creaking Cog
Bond funds may be a small cog in China's gigantic credit wheel. But if they get any rustier, the authorities' plan to gently shift corporate leverage into a lower gear could come unstuck.
Chinese debt mutual funds have chalked up returns of just 1 percent over the last 12 months, compared with an annual average of 10 percent for the past three years. More than 280 of the 300 funds for which Bloomberg has data for at least three years have posted losses since October, with ICBC Credit Suisse Credit Bond Fund sliding by 5.6 percent, and Bank of China Sheng Li 1 Year Interval Pure Bond Fund down 3.6 percent.
If the funds' performance doesn't improve, Chinese banks may be reluctant to park proceeds of their notoriously successful wealth management products with them. This would be worrying, says HSBC, because "asset managers have been the strongest bond buyers." As much as 80 percent of the bonds issued by China's policy banks last year were picked up by the funds, according to HSBC analysts Andre de Silva and Pin Ru Tan.
That isn't all. Beijing would also like to sell more bonds this year to boost fiscal spending. Upsetting a steady buyer could further push up the yield on 10-year Chinese government debt, which has jumped 50 basis points in less than three months. Corporate funding costs could also surge.
Things used to be a lot simpler. A healthy infusion of liquidity by the central bank would be enough to bring unruly Chinese yields under control and make bond investors happy. Funds would finance their debt purchases with short-term borrowings in the money market and enjoy souped-up leveraged returns. Investor concerns with credit quality would get swept under the carpet.
But those days are over. Chinese exchanges have asked individual punters to pack up and leave the repo market. Together with the counterparty risk highlighted by the Sealand Securities Co. fiasco, that could be one of the reasons for the sudden rise in China's money-market volatility last month.
A less spiky seven-day repurchase rate would take care of some of the nervousness, but that alone won't be an all-clear signal to debt investors. The correlation between the one-year yuan swap rate, which is the fixed cost needed to receive the floating seven-day repo rate, and the three-year yield on AAA-rated corporate bonds has fallen by half, from 90 percent in the five years before the surprise August 2015 yuan devaluation to about 46 percent since then.
Liquidity alone can't keep a lid on yields, not with a sixfold jump in corporate bond defaults last year.
China's corporate debt, which has swelled to 165 percent of the country's $11 trillion economy, gets its lifeblood from a $3.9 trillion wealth management industry in which bond funds play a crucial role. Any turbulence in their performance, assets and leverage could turn the smooth corporate deleveraging Beijing is hoping for into something cranky and unpredictable.
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Andy Mukherjee in Singapore at firstname.lastname@example.org
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Matthew Brooker at email@example.com