What can we read from China’s bond markets for growth, private credit and capital flows

• Based on our recently published reports on China’s onshore and offshore bond markets, we would like to draw some conclusions for China’s macroeconomic outlook. Using a bottom-up approach to analyze macro trends can prove useful to better gauge our forecast. In this note, we shall focus on three aspects, namely economic growth, private credit and capital flows.
• The massive increase in onshore bond issuances indicates Chinese leadership’s quest for additional credit into the economy is being taken care of, at least for bonds. But the irony is the bulk of onshore bond issuances come from the public sector instead of private firms. The reason may lie on the “reverse crowding out” that the public sector is experiencing as banks are asked to lend to private firms.
• From a sectoral view, we see one-fifth of onshore bond issuance goes to the real estate and/or infrastructure sector, excluding government bonds. In addition, while private firms are constrained by tighter rules on public-private partnership (PPP), shantytown renovation is the key focus for the government. As of May 2019, 37% of new local government special bonds are used in shantytown renovation, higher than 21% last year. This explains the pickup in property investment of 11.2% YTD YoY in May 2019, comparing to 4.0% for infrastructure.
• Another relevant point to China’s macro outlook is the limited onshore issuance by high yield private firms, which pushes them to the offshore market. In other words, riskier Chinese firms are piling up external debt and a good part of which is swapped back for onshore usage, even if the funding cost is clearly higher than onshore. This can only be explained by the scarcity of funding for this sector in Mainland China.
• Finally, despite the surge in the offshore bond issuance by private firms, overall issuance fell 12% in Q1 2019. This trend is inconsistent with a potential need for further capital inflows as the current account surplus shrinks potentially into a deficit. This is particularly true at a time of increasing trade tensions with the US, which increases the value of forex reserves as a buffer for a shortfall in exports. In other words, more offshore issuance, as long as proceeds are brought back to onshore, should be welcome.
• All in all, with external risks and domestic pressure on consumption, real estate and infrastructure investment will only become more important, which is reflected in the huge issuance to finance these sectors onshore. This is bound to continue given the increasing difficulties in the external environment. The focus on traditional sectors, together with the stubborn lack of funding for the private sector, indicates China is back to a quick fix for growth rather than increasing productivity. Finally, we expect the offshore issuance to be back as the current account narrows and more capital inflows are needed.

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