China Market Squeeze Starts to Strangle Small Businesses

By Shen Hong Features Dow Jones Newswires

A sharp rise in the cost of borrowing in China's bond markets is the latest sign of conflict between Beijing's effort to rein in financial-system risk and its long-term goal of modernizing the economy.

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In a little-noticed shift, Chinese companies in recent weeks have been able to take out medium-term bank loans at a lower interest rate than bond investors demand. The average yield on AAA-rated five-year corporate bonds, currently 4.90%, has been above the central bank's corresponding benchmark lending rate of 4.75% since May 3, according to data provider WIND Info.

The highly unusual reversal--it hadn't happened since records began in 2006--is largely down to Chinese regulators' attempts to tamp down speculation by investment funds that borrow heavily to leverage their bets.

"Beijing's deleveraging campaign is the main driver behind higher borrowing costs throughout the economy, from money-market rates to bond yields, and even banks are under pressure too," said Teck Kin Suan, senior economist at United Overseas Bank in Singapore.

The bond-rate surge is bad news for small and midsize private businesses, which typically have little access to bank loans. Corporate bond issuance has slumped and the number of companies scrapping bond plans has surged.

The surge also marks a setback for Beijing's longstanding pledge to let capital markets play a bigger role than state-run lenders in funding the world's No. 2 economy--a change that in theory should make capital allocation more efficient.

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The People's Bank of China's campaign to tame highly leveraged investing began last summer and intensified in February and March when it twice raised a suite of key money-market interest rates. Government bonds haven't been spared: The yield on the benchmark 10-year bond rose to a 29-month high of 3.69% on May 12 and has remained elevated since.

Faced with soaring borrowing costs, a record 382 Chinese companies have delayed or cancelled a total of 327.7 billion yuan ($48.2 billion) in planned new bonds since the start of this year, up from 348 companies and 284.2 billion yuan in the same period a year earlier.

Total new corporate-bond issuance this year stands at 1.7 trillion yuan, down sharply from 4.1 trillion yuan at this point last year. Subtracting maturing bonds, net corporate bond financing since the start of the year stands at a negative 521.3 billion yuan, compared with a positive 1.9 trillion yuan a year earlier.

While the economy has remained robust, growing 6.9% in the first quarter, some economists foresee a slowdown later in 2017 as it becomes harder for companies to raise funds. China's economy has been fueled in recent years by ever-rising credit, which has sent total corporate debt soaring to the equivalent of 150% of gross domestic product.

"The argument that now more companies will switch to traditional bank lending only stands in theory. In reality, it's very hard to do so because banks are under pressure and even big state-run enterprises are finding it difficult to get cheap loans now," said Liu Dongliang, senior economist at China Merchants Bank.

Mr. Liu said companies that have put off issuing bonds in hopes of a retreat in borrowing costs need to accept that this has grown unlikely.

"People need to give up their false hope now," he said.

Write to Shen Hong at hong.shen@wsj.com

(END) Dow Jones Newswires

June 07, 2017 08:50 ET (12:50 GMT)