China’s Policy Steps Drag Dollar Bond Stress to Least Since 2021

Stress in China’s $740 billion offshore credit market has eased to the least in almost two years, following a rally in developers’ bonds as authorities intensify a campaign to alleviate an unprecedented property crisis.

A Bloomberg index of Chinese junk dollar bonds, which are dominated by real estate firms, has surged nearly 60% from a record low in November to 77 cents on the dollar this week. It’s also at the highest in more than a year.

That helped bring the market’s stress gauge in December to level 3, down from 4 in November and marking a level last seen for Bloomberg’s China credit tracker in May 2021, when compilation of the data began. The tracker indicates rising levels of stress via a band of 1 to 6.

Policy makers have introduced a barrage of measures since November to arrest a housing slump and ease debt risks at developers, with outgoing Vice Premier Liu He describing the sector as a “pillar” of the world’s second-biggest economy. Investors entered 2023 with more good news, ranging from expanded efforts to cut costs for home buyers and plans to relax key financing curbs that were the hallmark of Beijing’s previous property crackdown.

“The pivot that China has done is far greater and faster than what markets have expected,” said Dhiraj Bajaj, head of Asia fixed income at Lombard Odier. “We see all the announcements around Covid Zero relaxation and sweeping property measures as a synchronized move and a constituted effort to bring China back on the growth trajectory for 2023 and beyond.”

It was a different picture in China’s local credit market, where the stress level rose to 6 last month, the highest on record since the credit tracker series began. It also marks the first time since then that onshore stress was higher than that offshore.

However, the pressure on the yuan debt market mostly resulted from a selloff in government and high-grade corporate notes as Beijing’s lifting of Covid curbs prompted investors to shift toward riskier assets. It’s less of a reflection of worries about default risks in a market where authorities have used easy funding conditions and debt compromises with investors to preserve stability.

Despite such temporary spikes in borrowing costs, China’s local credit market has avoided the record wave of defaults that hit its offshore counterpart last year. In the latest example of official efforts to minimize payment risk, a local government financing vehicle in one of the country’s poorest regions recently extended its bank loans for two decades, taking advantage of policy support to help it avoid defaulting on public bonds.

Some analysts caution that once the policy-induced euphoria dissipates, investors in Chinese developers’ dollar debt may face a reality check as offshore delinquencies continue and more payment tests arrive.

Times China Holdings Ltd. said last week it has missed payments on dollar bonds, a setback that shows the limitations of the plethora of government steps to ease the sector’s liquidity crunch.

“The main risk for 2023 is any big name defaults. There are still a number of coupons and maturities in the next three months, including some larger developers.” said Neeraj Seth, head of Asian credit at BlackRock Inc., in an interview last month. “The markets will be very focused now on the larger players because the assumption is that they will disproportionately benefit from the policies.”

The country’s top developer by sales, Country Garden Holdings Co., for one, will face its biggest repayment test in months in January, when nearly $700 million of dollar bond principal and coupons come due. The company has told some investors it has prepared funds to meet such payment needs, Bloomberg News reported Tuesday, citing people familiar with the matter.