China’s Policy U-turn Sharpens Focus On High-Quality Credits

Amanda Cheesley Deputy Editor 18 January 2023

China’s Policy U-turn Sharpens Focus On High-Quality Credits

PineBridge Investments has published its insights on credit opportunities in China, as the country rapidly ends it Covid controls.

Pinebridge Investments, which at the end of September looked after $133.4 billion, thinks that bond investors can finally eye high-quality credits as a route to reliable and diversified income without excess volatility, with certain sectors in China set to benefit from the domestic economic upswing.

In the final two months of 2022, China’s policymakers loosened strict pandemic controls and bailed out the real estate sector with more money than had been expected.These changes, coupled with ongoing supportive monetary and fiscal measures, have encouraged Pinebridge to think Chinese credit assets are worth holding.

Credit spreads have tightened in recent weeks and Chinese risk assets have regained ground. Pinebridge said in a note that underlying market conditions justify the moves.

In the near term, the waves of infections in different regions of the country will hit consumer sentiment and disrupt supply chains, the firm said. This risk is particularly high in the first two months of the year as the Chinese New Year holiday ushers in the world’s largest annual human migration. The firm expects soft economic data and corporate earnings in the last quarter of 2022 and the first quarter of 2023.

“However, looking beyond this disruptive and bumpy reopening period, it expects economic activities to gradually recover from the latter part of the second quarter onward, on the back of pent-up demand. Specifically, Chinese households have accumulated decent excess savings during the pandemic years,” the firm said.

“While the Covid policy pivot provides upside momentum for growth from the second half of 2023 on, the turnabout in property sector policy reduces a significant downside tail risk for the economy,” it continued.

It is forecasting an L-shaped trajectory for property sales, as it interprets the policy objective as intended to stabilise the market rather than to engineer a sharp recovery, as in the previous cycle. 

Annual national residential property sales could be 30 to 40 per cent lower than the peak level going forward, the firm continued. Nonetheless, this is a more than $1.5 trillion market in terms of annual sales, and high-quality developers should still play a role, albeit in much smaller numbers than before.

Pinebridge said it is optimistic about a reopening-driven growth rebound in China from the second half of 2023 and into 2024. However, it said there are uncertainties associated with the country’s long-term growth trajectory amid unfavourable demographic trends, potential increases in state control, and ongoing US-China tensions.

That being said, it views policymakers’ major long-term objectives – of reducing systemic risk, enhancing the quality of economic growth, and maintaining social stability – as credit positive.

These shifts have already been reflected in several key policy campaigns in recent years, the firm added. After short-term drags on growth when these initiatives were first introduced, the upshot from a credit perspective is that China is now generally better positioned than it was a few years ago, especially among the higher-quality credits.

Three themes to shape credit opportunities 
It thinks three themes are likely to shape credit opportunities in China in 2023. First, the extent to which domestic companies can benefit from monetary policy easing; second, which firms survive the bailout of the property sector; and third, who benefits from the eventual reopening of the economy, however bumpy it might be.

China is one of the few major economies currently easing monetary policy, the firm said. This means higher-quality issuers face an exceptional situation compared with corporates in other major markets. 

Average funding costs continue to decline due to the supportive onshore funding environment. By comparison, offshore investment-grade US dollar bonds are currently yielding more than 200 basis points more than IG onshore bonds, the firm continued.

This has been positive for credit fundamentals as well as demand/supply technicals of offshore US dollar bonds. Certain segments, including bank senior bonds and A rated SOE bonds, have outperformed in the past year on the back of this trend. The firm thinks that over time this will extend to more credits that can benefit from the cheaper onshore funding.

“More broadly, as China reopens, different sectors will benefit at different times, requiring investors to be selective in picking credits and entry points,” the firm continued. 

This puts a spotlight on companies with adequate financial buffers to withstand this period before eventually benefiting as the economy rebounds. It thinks the consumer and retail sectors in particular, which have been hit hard by Covid lockdowns, offer pockets of opportunity. Within Greater China, select issuers in Hong Kong and Macau are also set to benefit as both cities reopen to mainland China and the rest of the world, the firm said.

It sees opportunities in BBB rated central government-owned financial and non-financial SOEs, where it sees scope for spread compression against higher-rated SOEs.

Opportunities also exist in select private enterprises in the technology, media, and telecom and consumer sectors, which are pricing in excessive rating risks and are likely to benefit from China’s eventual reopening and policy easing. Property developers with adequate liquidity will also benefit, the firm added.

Areas with unfavourable risks
Stressed credits in the property sector, where policy support has come too late, look unfavourable as well as the hardware tech sector, which is subject to the risk of US sanctions.

Local government financing vehicles which face fundamental pressure and don’t offer sufficient spread to compensate for the potential risks also look unfavourable. While defaults remain minimal, policymakers can become more tolerant of defaults once the economy stabilises, the firm concluded.

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