China's Stalling Bond Engine Creates a Policy Dilemma

  • Maturing debt exceeds sales by the most on record this month
  • At least 117.5 billion yuan of local bonds have been canceled

China’s roaring bond engine is stalling heading into the new year, posing a quandary for policy makers as they try to curb leverage while keeping economic growth on track.

Bond issuance in December by Chinese companies and banks is 142 billion yuan ($20.4 billion) less than the amount of notes they must repay this month, data compiled by Bloomberg show. That’s set for the biggest monthly gap on record. As borrowing costs soar, firms have canceled or postponed at least 117.5 billion yuan of bonds, up from 29.7 billion yuan in November. That’s dragged total issuance down to 266 billion yuan, less than a third of November.

“Such a small amount of bond sales will be a blow to corporate financing,” said Wu Sijie, a senior trader at China Merchants Bank Co. “There needs to be a balance between the policy of deleveraging and companies’ demand for fundraising. It’s hard. The regulators need to draw a fine line.”

Read: How China’s medicine for bond markets risks sparking more defaults

The dilemma for policy makers is this: How to rein in runaway debt of zombie firms, while not disrupting the financial lifeblood for productive companies. Authorities have championed the bond market in recent years as a more transparent, well-regulated alternative to shadow banking and it had been thriving. Even after the slump in issuance, total note sales this year are already at a record 8.9 trillion yuan from 8.3 trillion yuan in 2015.

Financing-Cost Jump

The economy is ending the year on a bright note with industrial output expanding and retail sales accelerating. Authorities have used that improvement as an opportunity to trim leverage, increasing short-term money-market rates and tightening rules on using debt as collateral to buy even more securities. That pushed companies’ borrowing costs up to the highest in 19 months, with the yield premium of seven-year AAA corporate bonds over government notes widening to 121 basis points on Dec. 21.

Adding to concern about transparency in the bond market, China Guangfa Bank Co. said Monday that documents and seals for a letter claiming to guarantee note payments by the lender were forged, in the second such incident in the nation this month.

“If liquidity remains so tight, financing costs for the whole real economy will be very high, which is unsustainable,” said Wang Shen, a Shenzhen-based fund manager at Bosera Asset Management Co.

While taking steps to rein in risky investments, policy makers have also moved to assuage market panic. The People’s Bank of China on Tuesday asked some lenders to provide funds to the market via the so-called X-Repo system, which allows members to submit bids for repurchase contracts anonymously, according to people familiar with the matter.

“China’s corporate bond issuance is set to moderate in 2017,” said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore. “But we believe the policymakers will target a soft-landing in credit growth in the coming year, not a hard landing. So a slump in credit growth will likely prompt policy accommodations.”

— With assistance by Jing Zhao, and Judy Chen

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