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Breakingviews - China's bond squeeze could spread offshore
November 24, 2017 / 4:23 AM / in 24 days

Breakingviews - China's bond squeeze could spread offshore

By Pete Sweeney

An investor stands in front of an electronic board showing stock information at a brokerage house in Shanghai, China, September 2, 2015. Chinese stocks managed to bounce off from steep losses and ended Wednesday almost flat as fresh supportive measures from brokerages eased investor fears that Beijing may be intensifying a crackdown on illegal margin financing. REUTERS/China Daily

HONG KONG (Reuters Breakingviews) - It is time to start worrying about Chinese bonds. Tightening regulation has provoked a sharp selloff in the $9 trillion fixed-income market, with collateral damage to share. If stress is sustained, it could infect China’s giant pile of foreign-currency debt.

Anxiety has been increasing all year, as President Xi Jinping takes a tougher line on financial risk. Regulators have suppressed techniques abused by speculators, such as short-term borrowings using bond-repurchase agreements and so-called negotiable certificates of deposit. This crackdown, combined with expectations of higher rates, had pushed up benchmark yields without much panic until this week.

What tweaked local punters were central bank guidelines targeting excesses in the $15 trillion asset management industry. The benchmark 10-year treasury yield topped 4 percent on Thursday, its highest since 2014.

Overseas investors have watched Chinese markets closely since 2015, when a stock crash was felt around the world. Bonds are far more important. Stressed companies and financial institutions have come to rely heavily on short-term debt issues to repay bank loans and maturing wealth management products. The sector remains patchily regulated and distorted by implicit guarantees.

At the same time, cheaper funding costs led many mainland firms to borrow in dollars. Thomson Reuters data shows Chinese issuers sold more than $100 billion of bonds in dollars, euros and yen by the end of September, up 24 percent from 2016. They have also borrowed liberally directly from banks. Foreign lenders’ China exposure grew 13 percent to hit a record high in the first half of 2017, Fitch Ratings says, to stand at $1.9 trillion. Most of that will not be in yuan.

If the local rout turns into a full-on crash, that could create problems for these markets. Borrowers, seeing rates spike at home, would naturally seek to borrow more in foreign currencies. But they might struggle to find investors: most investors in Chinese dollar bonds are also from the People’s Republic. If stress is sustained, weaker issuers will struggle to borrow in any currency, and start defaulting on offshore obligations first. That would be a far bigger headache than 2015.

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