Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

The China Bond Connect system that started Monday opens doors for foreign institutional investors to cherry-pick in a $700 billion corporate securities market where few issues are rated below a lofty AA.

Part of the reason for that is the youth of the market: As recently as 2006, all issues required bank guarantees, so domestic rating agencies graded all corporates AAA. Even now, of the 1,500 bonds of publicly traded companies covered by China's big four agencies, 70 percent score AA or above -- and a whopping 60 percent are AAA.

Lure of Bond Connect
China's five-year AA local-currency bond yields are double those in the U.S.
Source: Bloomberg

By a proprietary Bloomberg metric, however, at least eight of those AAA issues actually were high-yield, with a greater than 0.52 percent probability of default over the next 12 months. Would a state-owned firm like China National Building Material Co. -- which belongs on the third rung of junk, according to the Bloomberg risk monitor -- ever be allowed to welsh? The cement maker is rated AAA at home. 

Let's not be too cynical: Give China the benefit of the doubt. For one thing, there's little history of delinquency. The nation's first corporate bond default occurred only in 2014. In addition, more than 85 percent of corporate issuers are state-owned enterprises, according to a Goldman Sachs Group Inc. estimate, and SOEs have been able to avoid default through local government and bank bailouts. 

Top Notch, or Perhaps Not
At least eight issuers rated AAA by one of the four main local Chinese rating companies are high-yield, according to a Bloomberg default risk monitor
Source: Bloomberg

For those who don't mind doing their own due diligence, Chinese corporate bonds may be attractive. An average AA bond with a five-year maturity yields 5.4 percent, more than double the 2.65 percent on its U.S. counterpart, Bloomberg data show.

Consider, too, that amid alarmist headlines about China's ticking corporate-debt time bomb, firms' ability to service borrowings is getting better. For 900 publicly traded Chinese companies with a market cap greater than $100 million, retiring all of their net debt would take an average of 0.25 years of operating income, versus 0.91 three years ago. Deleveraging is far from complete, but it's certainly under way.

We've seen how assiduously China wooed MSCI to include A-shares in its benchmark index. Membership of a fixed-income gauge like the prestigious J.P. Morgan Global Bond Index could be more gratifying still.

Investors may soon get a more complete picture. Beijing promised to open its bond markets to foreign rating companies this month, so the likes of China National Building Material could have a more realistic grade from Moody's Investors Service or S&P Global Ratings in a year or so. This connection is looking clear.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Shuli Ren in Hong Kong at
Andy Mukherjee in Singapore at

To contact the editor responsible for this story:
Paul Sillitoe at