Cheating on the Test Does Not Mean You Passed

One of the most surprising events within China’s corporate bond market this year is the recent slowdown in bond defaults, despite the economic pain produced by the global COVID-19 outbreak. The slowdown is an illusion, at least in part. In reality, Chinese bond issuers are simply becoming more creative to avoid technical defaults, using techniques such as persuading or threatening investors to withdraw put options, extension of bond maturities, or swapping old bonds for new ones, among others.

The effect of these inventions on the bond market is predictable: investors know less about actual credit risk, but formal defaults decline. The net result is likely to be wider credit spreads for riskier issuers, particularly private firms, relative to firms perceived as safer, a distinction that will likely privilege larger state-owned firms.

Posted May 4, 2020
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