Perspective

China’s US dollar-denominated bond market remains robust despite economic challenges


The onset of the Covid-19 outbreak at the beginning of the year has triggered significant volatility across global markets. As a result, investors are inclined to increase their allocation of assets that generate stable income; Asian corporate bonds have fared well, particularly China-issued dollar-denominated bonds. However, given the global economy is facing multiple challenges related to the Covid-19 pandemic, default rates are also expected to rise.  As deglobalisation gathers momentum, global supply chains, for instance, have been greatly affected by severe disruptions. China’s export industry is by extension impacted, and there is now some real and potentially heightened default risk in some segments of the manufacturing sector.

When evaluating the potential default risk of China US dollar bonds, investors should consider the market structure. Compared to other emerging markets, issuers in China are biased towards those with domestic focus and proven track records.  They are also less likely to be affected by broad political or macroeconomic changes. In addition, there is diversity of choice as issuers cut across different industry sub-sectors. With this in mind, China US dollar corporate bonds are thus expected to have relatively strong performance.

China US dollar bond market largely spared from recent oil crisis

The defensive nature of the China US dollar bond market has been clearly demonstrated during the recent oil crisis. During this period, oil-related businesses struggled to adjust as oil prices experienced unanticipated downward pressure. This impacted companies in most other markets, and the shock translated to an increased risk of default. However, given energy-related companies only account for a small proportion of total issuance, the reverberations on the Chinese market was comparatively marginal.

At the same time, the Chinese export market remains somewhat resilient despite US-China trade tensions – companies that rely on US exports for revenue only account for 2% - 3% of the China US dollar bond issuer base. Conversely, this market is dominated by government agencies, banks and real estate companies, who together account for more than three quarters of the overall market issuance.

Low default risks due to low global correlation

Zooming into the major sectors, government-affiliated agencies have historically had lower default risk and higher credit ratings. Likewise, in the banking sector, capital reserve ratios are considered sufficient at large Chinese banks, and this contributes to the overall health of the bond market. As for the local real estate market, since domestic demand has been the main driver of growth, the correlation to global market movements is almost non-existent; this makes the sector less sensitive to political situations. The above therefore explains why the overall default rate in China has not been as severe as may have been expected.

In addition, it is worth noting that China’s latest GDP figures reveal an increase of 3.2% year-on-year in the second quarter - reversing the decline in the first quarter and surpassing the market’s growth forecast of 2.6%. This is largely due to the relatively early management of Covid-19, which enabled an earlier restart of economic activities. A further boost was also achieved through the implementation of monetary easing policies and infrastructure investments. The country’s economic rebound has definitely had significant impact on lowering the default rate that would otherwise have been expected (under current global market conditions).

All things considered, we are optimistic on the 2020 outlook of China’s economic growth and expect the country’s annual GDP growth to reach 2.2%. This is despite the prediction in the recent World Economic Outlook Report from International Monetary Fund (IMF) that posits a 4.9% contraction of the global economy this year. China then, will be the only major economy that is able to maintain economic growth amidst the current downturn.

Apart from the abovementioned sectors that are traditionally preferred by investors, there has been new and emerging opportunities.

In the past, investments in Chinese technology companies have mainly been through stock or private equity markets. Today, China’s technology sector has grown tremendously, and leading technology companies have transitioned from the growth phase to the maturity phase, with an increased interest in fundraising through bond issuance.  

In addition, there has been a growing trend for Chinese companies listed abroad returning to make their secondary listings in Mainland China (e.g. A-shares) or Hong Kong. Some of these companies are familiar and well-known names, which will no doubt attract a lot of investor interest should they decide to issue corporate bonds.  

Active management to capture opportunities

The Covid-19 pandemic outbreak in March this year coupled with oil price slumps triggered a liquidity crisis and collapse in market confidence. During this period of market panic, investors started to let go of corporate bonds in large volumes, even those with resilient fundamentals and healthy balance sheets. As a result, the yields of these bonds rose several hundred basis points from normal levels. Recognising the opportunity, it was at this point that the Schroders’ Asian Fixed Income team bought into corporate bonds that presented attractive valuations.

As central banks around the world started to launch large-scale monetary easing policies, the Asian bond market quickly stabilised. In fact, some corporate bonds that fell sharply recorded remarkable rebounds.

In the face of the abrupt changes in the economic environment and looming market uncertainties, a flexible and active management style may be able to help investors reduce investment risks while seeking better returns in an ultra-low interest rate environment. The same is true for investments in the Asian or Chinese bond markets. 

 

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