Understanding China’s Bond Market

China’s bond market, despite having all the important components of developed market, is still heavily controlled by the central government.

The government is reluctant to relinquish control of the market, as it is one of the main ways in which it controls growth in the economy at large. By heavily restricting which firms can enter the bond market and how much they can raise it increases reliance on bank lending.

Another factor that complicates analyzing China’s bond market is way in which the government sets both deposit rates and interest rates. By ensuring low deposit rates and high interest rates the State guarantees high returns for the banking sector. Given this high return on loans it seems strange that banks would invest at all in the relatively low returns available on the bond market. The reason they do, is the government is able to restrict the overall level of lending. So when banks reach their limit, they dump remaining funds in the bond market. This means bond prices do little to reflect real the real price of borrowing.

That said though, the market is seen a relatively well-informed indicator of investor sentiment on the economy at large. The reason is the primary factor influencing bond market yields, given the level of State control, is future expectations of inflation and interest rate rises. With so many investors closely connected to the government, PBoC, expectations of overheating lead investors to ask for higher returns. This is because as economic sectors begin to overheat, inflation rises and the government raises interest rates to cool the economy. Anticipating this rise, investors ask for higher returns to compensate.

Information on bond market yields is available from the China Central Depository and Clearing Co.