China's $12 Trillion Onshore Credit Market Brushes Off Defaults

Preserving calm in China's domestic market is a priority for authorities as they roll out an ambitious campaign to reduce financial risk. It's necessary to allow more payment failures to debunk assumptions that the state will save borrowers, but too much stress could cause a domino effect. The Covid-zero policy will add to the challenge.

China is counting on a stable government bond market to raise much-needed public funding, even as foreign investors are selling the notes in the longest streak of outflows since 2015. According to Citic Securities Co., local authorities will sell at least 1.5 trillion yuan in the month of June. Chinese banks buy a lot of debt.

After high-profile defaults at giants like China Evergrande Group and Kaisa Group, the stress in the debt-saddled property sector has mostly been contained to the offshore market. As borrowers prioritize making payments or seeking extensions on their local bonds, global investors have absorbed most of the losses.

Despite China junk bonds seeing their ninth-consecutive month of losses in May, returns in the local corporate bond market have remained positive for 21 of the past 24 months.

After more than a year of difficulties for developers, policymakers have stepped up efforts to ease the credit crunch by cutting key interest rates. New credit-guaranteed local bonds can be sold by a small group of builders.

S&P Global Ratings analysts, including Wilson Ling, believe that the government arranged for securities firms to provide protection, despite the fact that the guarantees only cover part of the principal. Beijing is trying to boost confidence.

Over the past two years, the resilience of China's local bond market has attracted more global buyers. The recent move to make it easier for foreigners to access corporate bonds via the exchange market may signal a desire to encourage more overseas capital.