Investors Head for Safety as Chinese Defaults Stack Up

by on March 21, 2014 1:28 pm BST

Global investors head for safety in Chinese government bonds in the wake of corporate defaults and the looming systemic risks that may follow. Purchases of onshore debt increased by 16 percent this year with many investors see an alternative investment opportunity with the yuan’s precipitous decline.

The yuan, also known as the renminbi, has declined almost three percent this year and making debt attractive. According to the Shanghai Clearing House and China Central Depository & Clearing Co, investors increased their holding from 331.9 billion yuan at the end of 2013 to 384.1 billion yuan as of the end of February. Rajeev De Mello, head of Asian fixed income at Schroder, said “it has definitely become interesting at these levels to accumulate currency positions.” Although, the decline in the yuan is not expected to last long-term. Due to China’s lack of allocation globally, government bonds remain relatively safe to most managers.

There has been a couple corporate defaults already, and market participants are uncertain on whether or not it can be contained within China. Companies operating in Chinese real estate are currently under pressure. Furthermore, with the large shadow banking industry, it is quite difficult to determine the total amount of credit floating around.

While defaults are seen as a tough love solution, it will reset credit-market discipline and prevent moral hazard risk, similar to what happened in the US financial crisis; but, how much will the world wince when the band-aid is yanked off?