William Xin, Eastspring Investments
There has been considerable uncertainty in China’s capital markets this year, triggered by stricter regulations, deleveraging and defaults which has dented investor confidence.
Nevertheless, Eastspring Investments “continue to see opportunities in the onshore market and regard this as an opportune time to add alpha on a selective basis”. Some other international investors seem to agree.
In Eastspring’s recent global investor survey on Asian fixed income, 63% of respondent picked China bonds as a key strategy to invest in over the next 24 months, despite the significant regulatory changes and the ongoing default risks faced by China’s property issuers.
“The fact remains that China bonds continue to appeal, and asset managers with mastery of the local market and issuers stand to benefit,” said William Xin, head of fixed income, Eastspring China.
The total size of the onshore credit bond market is about Rmb50.1trn ($7.86trn), with state owned enterprises (SOEs) and local government financing vehicles (LGFVs) representing the dominant issuers in the segment.
LGFVs were set up by local governments in the 19902 as a subset of SOEs to finance off-budget public investments. After the 2008 global financial crisis, LGFVs were used to fund China’s infrastructure boom, and with implicit guarantees from local governments in place, they borrowed heavily and easily.
However, their growing debt forced the Chinese authorities to tighten their oversight over LGFVs. Additional guidelines were issued to banks and insurance institutions earlier this year to discourage new loans to LGFVs that have implicit guarantees from local governments, triggering concerns on LGFVs’ refinancing capability.
The government also indicated there would be no bailouts for indebted LGFVs, causing some market volatility in the onshore market even though to date there has not been a default on a publicly listed LGFV bond.
Credit differentiation
“Despite these ongoing issues, one cannot ignore the potential opportunities,” said Xin. LGFV bonds account for more than half of the government-related issuance, with more than 5000 issuers, so “adopting a credit differentiation approach and tapping on deep local market knowledge is the best way to invest in this market”.
In particular, Xin said it is important determine the credit strength of an LGFV’s local government sponsor and the role it plays in supporting policy objectives.
But, he warned that banks are likely to take a more cautious stance (and longer approval process) for both loans and bond investments for LGFVs, which may lead to a lower supply and higher issuance cost in the primary market for certain LGFVs.
As a result, the LGFV market will undergo more restructuring which will likely weed out the weaker players. Eventually the aim is to separate LGFV credit from the local government credit, which will render LGFVs to be treated at the same level as SOEs and privately owned enterprises (POEs), according to Xin.
“Ultimately, the Chinese government has the political will and policymaking capacity to steer the market back into calmer waters,” he said. “Previous experience has shown its ability to contain systemic risk and maintain overall financial stability.”
