A 'new wave of defaults' by Chinese companies has come crashing down and could send ripples through its stock market

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  • China has been pursuing a deleveraging campaign. 
  • Corporate bond defaults are rising in the country, especially among public companies.
  • Risk in the bond market could spread to stocks.

China’s turning down the money tap, and the effects are starting to be felt in the bond market. 

Chinese policymakers have been focused on a deleveraging campaign, with total social financing, a measure of credit growth, decelerating to 10.5% year-on-year in April, the slowest reading since 2005. The main driver of that slowdown has been a contraction in off-balance sheet lending.

That in turn has helped drive an increase in corporate bond defaults, which could cause market turbulence in the coming months, according to a team of Macquarie Research economists led by Dr. Larry Hu.

“A new wave of defaults in China’s RMB20tn corporate bond market has caught the eyes of investors recently,” Hu said. “Credit spreads have shot up to new highs over the past two years and could rise further in June.”

Bond defaults increased last month, which also saw more nonpayments than the same period in years past. The default rate, which is the percentage of corporate bond defaults against the total maturing value, was 0.7% between January and May. 

The rate is only slightly higher than a year before and less than 2016 levels, but an increasing share of those defaults are happening in the public sector. Listed companies missed nearly 4.5 billion yuan worth of payments on 2018 bonds between January and May, which Hu called an “unprecedentedly high” amount.

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The shift raises concerns that credit risk could spread from the bond market to the equity market. Public company Beijing Orient Landscape & Environment Co had to reduce its bond issuance last month because of inadequate demand. Shares of the company sank 23% following the news, and trading was suspended

About 1.5 trillion yuan in corporate bonds will mature over the next year. And a potentially “vicious” credit cycle could make things worse, according to Hu. Lower credit growth can discourage risk appetite, which lowers credit growth further. 

Credit growth fell to 10.5% year-over-year in April, which is its slowest pace since December 2005. And net bond issuance turned negative in May, as companies lowered or canceled new bonds.

“Tightened liquidity due to the ongoing deleveraging campaign could cause more market turbulences in the coming months,” the note said. 

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Read the full article from it’s original source: http://uk.businessinsider.com/china-corporate-bond-defaults-could-cause-market-turbulence-2018-6

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