A new type of Chinese junk

The authorities are looking to introduce junk bonds

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17 Feb 2012
Week in China

The Predators' Ball was a lavish event held by Drexel Burnham Lambert in the 1980s to promote its fastest-growing product: the junk bond. Quite what Michael Milken, head of Drexel's bond department, thought of the naming of the event goes unrecorded. Later indicted on 98 counts of racketeering and fraud, Milken never liked the term 'junk' itself, arguing for something more wholesome. "Junk bonds? There's a better name for the bonds that fuel 95% of American business," he griped. "Perhaps something like Corporate Growth Bonds. Or State Development Bonds. Or Job Creation Bonds".

Regulators in China will now be mulling similar presentational issues, as they push to introduce high-yield debt (or 'junk bonds') in their own capital markets.

With a credit rating below investment grade, junk bonds pay a higher return to offset the greater risk of default.

With a credit rating below investment grade, junk bonds
pay a higher return to offset the greater risk of default.
But the CSRC, the securities regulator, and the Shanghai Stock Exchange are both heavily promoting the idea of junk bonds, reports Caijing, which thinks that the bonds could come onto the market as early as this month. Others say that this is too optimistic, and that the CSRC will spend more time ensuring investor support for a successful launch.

In recent years, China's bond market has grown rapidly, with the amount of corporate debt issued in 2011 double that of 2010. But most companies with good credit ratings have already issued as much as the regulations will allow (no more than 40% of net assets), meaning that debt market growth is set to slow.

Junk bonds are also expected to offer more of an opportunity for unlisted, small and medium-sized companies to gain access to credit.

Of course, a potential downside is that defaults will become a more common occurrence. Investors will also need to conduct more research on the creditworthiness of the companies they wish to invest in. To address both concerns, the Shanghai Stock Exchange recently made the distinction between ordinary and professional investors. Only the professionals will be able to buy junk debt, while ordinary investors will be directed towards assets assumed to hold much lower risk, such as government debt and high-grade corporate debt.

In addition, junk bonds will be kept out of the inter-bank market.

Meanwhile, debt repayment is very much in the headlines once again this week, although in this case the loans in question were made to entities connected with China's local governments. Under the terms of the latest announcement, city treasurers will be allowed to roll over their bank loans into longer repayment periods. The move is a consequence of the stimulus package launched to fend off the financial crisis, which lumbered local governments with Rmb10.7 trillion of debt, much of it borrowed from banks via local financing vehicles (first mentioned in WiC in issue 48). A substantial chunk of this debt needs to be repaid by the end of the year, hence the urgency.

The roll over measure is effectively an admission that local governments are unable to pay back many of these loans over the shorter term. Much of the borrowed capital went into infrastructure projects, many of which are yet to generate sufficient returns.

"We are not talking about a cashflow problem. We are talking about a big cash shortfall problem," Zhu Ning, of the Shanghai Advanced Institute of Finance, told the Financial Times.

The scheme is expected to give local governments more time to get on top of their debt.

The scheme is expected to give local governments more time to get on top of their debt.

Another lesson has also been learned in the process: that it's probably better (i.e. more transparent) to encourage local governments to issue bonds rather than borrow from banks. "Five or 10 years from now, local governments will borrow very, very little from banks. Their debt structure will be almost entirely bonds," Fan Jianping, an economist at the State Information Centre, told the FT.

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