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To help explore China’s debt markets, Catherine Yeung, Investment Director, and Marty Dropkin, Head of Asian Fixed Income & Hong Kong Investments, speak to George Efstathopoulos, Multi-Asset Portfolio Manager, and Monica Li, Equities Director. With additional contributions from Olivia He, Portfolio Manager, and Claire Xiao, Credit Analyst.

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Highlights 

Introduction to China’s debt markets 

Catherine: “A lot of the financial headlines we're seeing about China involve also debt of one form or another, whether it's a real estate company that borrowed too much or got into trouble, or a new macro policy aiming to rein in leverage within the banking system, or even some innovative digital solutions to improve access to credit for consumers. So, it seems like debt continues to be a very strong focus for investors right now. This against the backdrop of the global pandemic, especially with the increased cases we're seeing in China.” 

Marty: “I think one of the things that I know we'll touch on here is it's really important to differentiate between what we call good debt and bad debt. You know, and if I can speak about that very generally for a minute, while companies going under and filing for bankruptcy may be newsworthy, this can also help in reducing the so-called moral hazard if it means that the credit risk being priced in is actually something investors are looking at.”

Catherine: “Yeah, and of course, Marty, being in fixed income, you know all too well that another large example of where debt is in fact a positive force is China's onshore bond market. So, it stands, correct me if I'm wrong, around $20 trillion, right, in outstanding issuance. It's a domestic bond market which has nearly doubled over the last five years, now the second biggest bond market in the world behind the United States.”

Marty: “No, you got that right. And look, for fixed income investors, we are witnessing what is going to be a huge opportunity and it's taking shape right here and right now. But accessing the debt markets in China, it's not always so easy. And I think failing to do your research appropriately, it can really lead to a mispricing of the risk if you're not careful.”

On China’s onshore bond market

Olivia: “The onshore bond market is actually quite big. It's growing more than China GDP, it's now, the size is around RMB $130 trillion and more than half of them are rates so, it's as you can think, it's a relatively good financing platform for the governments. It will also give investors a way to support the real economy, besides the equity market, with relatively lower risk and more stabilised return. For high yield issuers, though, there's a big default risk because unlike bank loans, you cannot just go to a bank and ask for another round of refinancings, still have to follow some open market rules.”

On the Renminbi

George: “So, the renminbi has been strong and I think it's been interesting that, you know, at the height of the geopolitical risk sort of, you know, later stages of sort of February, early March, it actually ended up being the defensive currency that's, you know, that ended up being the safe haven, unlike the Yen, for instance. Now, China wants the Renminbi to essentially take a more central stage in the world when it comes to trade, financing, they want the Renminbi to be a stable and strong currency. That is definitely a key objective and the opening up of the capital markets further supports that. If you look at, you know, flow, one of the key reasons the Renminbi has been strong is because of the very, very strong flows into China government bond markets the past few years. Another reason why it's been very strong is because the past few years we've had very strong exports coming from China. So, that's money, that definitely helps on the currency on the balance of payments. At a time when China, you know, people in China, the population has not been able to get out, has not been able to spend the Renminbi.” 

On the government bailout of China Huarong Asset Management 

Claire: “I'm not sure if investors have learnt much from this case because if you look at market price, Huarong’s bonds have recovered a lot. The perception of strong government support for these state-owned companies is still well received by investors. In China, and in this case, even though some of these state-owned companies are not very efficient, they still can get enough money and is still at very cheap cost. The good thing is that this can keep debt rolling, avoid defaults. But the bad thing is that they are not necessarily helpful in terms of making profit or produce GDP from macro level. China is looking to fix this issue with a reform amongst state-owned companies, allowing more defaults and a more effective way of allocating capital. But it's going to be very gradual. This is because they don't want to rush things and cause systematic risk. For us investors, the important thing is to keep an eye on China's approach towards deleverage and how they balance between reform and risk.”

On the supply of mortgages

Monica: “So before those new caps were introduced, supply for mortgage was never an issue because it's always in such hot demand because people are just waiting to buy properties. Since end of 2020 when new cap was introduced, it's getting longer and harder for people to get mortgage to be approved by their banks. And now, most recently, as George mentioned, we are seeing signs of relaxation on mortgage front as well. So, actually, for each city, they also have their own rules, like how many properties you can buy in addition to the mortgage restrictions. So, for example, some cities forbid you from owning a third house, like in Shanghai where I am now. But when the new rules were introduced, people were also kind of being creative to find other ways to fund their homes, like they're using other types of loans like consumer loans, which are actually illegal and are being picked up by the regulators. And some people are also creative in a way that they file for divorce, so they become first-time buyers if they have maxed out the number of apartments they own as a couple. But those loopholes are increasingly being plugged by the local regulators.”