Monetary policy alone will not fix China's cooling economy. Photo: AFP / Fred Dufour

China’s corporate bond market is heading towards a record-breaking year, and not in a positive sense. Analysts say that 2018 will see the number of defaults hitting a new high, according to a report from Caixin on Friday, amid tightening policies enacted as part of Beijing’s deleveraging campaign.

“Default risk has risen due to tighter regulation, and investors should be fully aware of the possibility of a vicious circle caused by a credit crunch and deteriorating market confidence, resulting in further defaults,” said Yan Yan, chairman of China Chenxin Asia Pacific Ratings.

Yan noted that the large amount of bonds maturing through 2020 is contributing to the risk of default. 5.68 trillion yuan of the total will reach maturity by the end of 2018.

While one could reasonably expect such adverse effects resulting from the policies aimed at cutting excess leverage, which ultimately hope to increase the stability of China’s financial system, investors should also be wary of a spillover into the offshore bond market.

“Some of that spillover has already occurred. Private oil producer China Energy Reserve and Chemicals Group announced in a May 25 filing with the Hong Kong Stock Exchange that it will be unable to make a scheduled payment on its $350 million dollar bond, citing a ‘liquidity crunch’,” according to Caixin. “The default sparked fears of further defaults, as the company said the missed payment could trigger cross defaults on five other offshore debt securities that were due to mature.”

The market has seen 14 corporate bond defaults thus far this year, Bloomberg reported on Sunday. “As well as cutting their own holdings, Chinese banks have pulled back from lending to other firms that use the funds to buy bonds, exacerbating the pressure on the market,” according to the article, which cited research from Rhodium Group.

“Additional bond defaults are especially likely among those property developers and local-government financing vehicles which have relied on shadow banking vehicles for their funding,” the firm said.

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