April 11, 2019 / 2:19 AM / in 10 days

Breakingviews - Bond market addition will test China’s resolve

A man checks phone at Lujiazui financial district in Pudong, Shanghai, China March 14, 2019. REUTERS/Aly Song

HONG KONG (Reuters Breakingviews) - Chinese bonds will test Beijing’s resolve. Index inclusion is pulling global investors into the onshore fixed income market. Implausible ratings and thin liquidity are among its fixable teething issues. The real question is if Beijing will meddle with bonds in bad times, as it has in stocks.

Onshore bonds started, earlier this month, to be included in the Bloomberg Barclays Global Aggregate Index, a process that could lead to around $150 billion of inflows to the market. At least two other index providers are considering following suit. That’s a sea change for the $13 trillion market, where foreign investors hold only around 2 percent of bonds.

The market has flaws, though. About half of interbank bonds are labelled as ultra-safe AAA, while a tiny sliver are rated lower than AA. Domestic agencies are accused of ratings inflation and conflicts of interest. Officials last year punished one of the most prominent for hawking consulting services to companies it also rated, among other misdeeds.

Chinese bonds were once dismissed as bank loans in disguise. That adage still contains a grain of truth: around 70 percent of sovereign bonds are held by banks, for instance, frequently to maturity. That means secondary liquidity is sometimes thin and concentrated in short-dated securities. A large majority of corporate issuers are state-connected, with implicit guarantees. A host of other issues, including several different regulatory agencies, also create confusion.

In the long term, the bigger question is how Beijing will react if things turn sour and, say, a wave of defaults arrive. Debt market routs can be a harrowing experience for any developing country. China’s own equity market crash of 2015 led to widespread trading suspensions and the creation of a government-backed “national team” to support prices.

Initial signs appear promising. Officials seem intent on broadening access to the bond market and loosening regulations in key areas, supported by a steady drip of new measures in recent months. Their overarching aims of weaning the economy – and in particular, state-owned enterprises – off an outsized reliance on bank lending is sound. But the real test is still to come.

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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