The Impacts of Bond Defaults on the Yields of China’s Bond Market
The Impacts of Bond Defaults on the Yields of China’s Bond Market27720131152818Liu YunBackgroundRecent Chinese Bond Market has drawn wild attention to its breakdown process of Rigid Payment rule since a series of bond default events happened from 2014. What will bond default events bring to Chinese bond market? More specifically, is it a positive signal perceived by investors? Does the effect diminish with more and more similar events happening afterwards? Which bond categories are specially affected and how? These are the questions that attract me to look into.The implicit Rigid Payment system which requires companies to unconditionally pay the principal and interests to investors, is deep rooted in Chinese bond market. It was created by the government to protect the investors and support the stable development of the market. In recent years, China has been experiencing a slowdown of economic growth and the overall environment is increasingly difficult for enterprises now. Many companies are suffering from the deterioration of cash flows. Therefore, it is particularly a big burden for them to pay back their liabilities. However, investors are not very worried about the situation because of the belief that the government will bail them out finally. This is indeed a normal practice under the hidden Rigid Payment rule. But the problems still exist and the risks are being accumulated. In an already world’s third biggest bond market, is the government still willing to serve as a saver for all the close-to-default bonds?
The event happened on March 4th, 2014 definitely marked a milestone for Chinese bond market. “11 chaori bond” declared that the company failed to pay back the annual interest to investors on the predetermined payment date. Since then, bond default events happened more and more regularly. The default company includes both private enterprises and state-owned ones and the default product varies from corporate bonds to medium term note. This phenomenon has aroused wild discusses and concerns about the effects and the extent of the breaking process of the Rigid Payment rule.In fact, there has been long time expectation of bond default events in Chinese financial market. It is increasingly recognized by regulators that China needs real credit defaults to reduce the moral hazard created by Rigid Payment rule and to develop a healthier market. In this sense, allowing bond defaults is good for the market in the long run in terms of risk explosion and bond pricing. However, in the short period, investors are warned of the real risks so that there might be a significant negative sentiment in the market.