Bond Market Development
The People’s Republic of China issued two series of bonds in 1950 and 1954-1958. As discussed in Chapter 3 (see also Burdekin and Wang, 1999), however, the government’s new “Victory bonds” were sold with the help of coercive methods.
No further bond issues were made until after economic reforms began in 1978. When government bond issuance did resume in 1981, these bonds were initially paid for by payroll deduction and represented little more than another form of taxation. In an attempt to elicit voluntary purchases, the coupon payments were gradually raised and maturities shortened from ten years down to two- or three-year terms during the 1980s. With no secondary market in place, the only way to trade government bonds was with black marketers, who apparently did not pay very good prices. Bei, Koontz, and Lu (1992, p. 158) point to sales “for much lower than par value, sometimes for as little as fifty percent of par.”In a path-breaking step, the Shenyang Trust and Investment Company launched over-the-counter security trading onAugust5,1986. ByJune 1988, trading had expanded to sixty-three cities and security trading volume in that year was RMB 2.62 billion, with government bonds accounting for over 92% of this total (Burdekin and Hu, 1999, p. 68). Meanwhile, reliance on enforced bond purchases declined until, in 1993, all government bond issues were underwritten by financial institutions. The first underwriting syndicate was formed in 1991 (Bei, Koontz, and Lu, 1992, p. 161). Another key step was the October 1990 establishment of a nationwide information and exchange network that achieved more uniform pricing. The Wuhan Securities Exchange Center, established in 1992, briefly served as the main bond trading hub until it was superseded by the new national stock exchanges (Bottelier, 2007).
When the Shanghai Stock Exchange opened on December 19, 1990, followed bythe Shenzhen StockExchangeonApril 11,1991, governmentbonds dominated the floor trading.
Over 83% of the RMB 37 billion total trading volume in 1991 was accounted forby government bonds (Burdekin and Hu, 1999). Their share of total trading volume subsequently dropped to 39% in 1992, and 10% in 1993, after stock trading got fully underway in China in 1992 (Burdekin and Hu, 1999, p. 68). However, there was a fresh surge of interest in government debt after a new series of indexed bonds was issued in June 1993 in the face of spiraling inflation in 1993-1994 (Chapter 3).[129]Table 8.2. China’s Public and Corporate Bond Issuance, 1986 2005
| Issues of Public Bonds | Outstanding Public Bonds | Issues of Corporate Bonds | Outstanding Corporate Bonds | |
| Dec-86 | 6.25 | 29.34 | 10.00 | 8.38 |
| Dec-87 | 11.79 | 39.73 | 3.00 | 8.64 |
| Dec-88 | 18.89 | 56.42 | 7.54 | 11.50 |
| Dec-89 | 18.73 | 73.83 | 7.53 | 14.64 |
| Dec-90 | 23.42 | 87.89 | 12.64 | 19.54 |
| Dec-91 | 28.00 | 97.27 | 25.00 | 33.11 |
| Dec-92 | 45.59 | 127.45 | 60.96 | 80.20 |
| Dec-93 | 38.48 | 157.25 | 2.01 | 76.80 |
| Dec-94 | 113.76 | 228.64 | 16.18 | 67.99 |
| Dec-95 | 151.09 | 330.03 | 21.61 | 33.27 |
| Dec-96 | 184.78 | 436.14 | 26.89 | 59.77 |
| Dec-97 | 241.18 | 550.89 | 25.52 | 52.10 |
| Dec-98 | 380.88 | 776.57 | 14.79 | 67.69 |
| Dec-99 | 401.50 | 1,054.20 | 15.80 | 77.86 |
| Dec-00 | 465.70 | 1,367.40 | 8.30 | 86.16 |
| Dec-01 | 488.40 | 1,561.80 | 14.70 | 100.86 |
| Dec-02 | 593.43 | 1,933.61 | 32.50 | - |
| Dec-03 | 628.01 | 2,260.36 | 35.80 | - |
| Dec-04 | 692.39 | 2,577.76 | 32.70 | - |
| Dec-05 | 704.20 | 2,877.40 | 204.65 | - |
Note: All data are in billions of renminbi.
Source: Great China Database.
The government actually announced that all bonds with maturities over three years would be indexed retroactively as of July 11,1993. Treasury bond futures were introduced on the Shanghai and Shenzhen Stock Exchanges in October 1993. Total public bond issuance more than tripled from RMB 38.48 billion in 1993 to RMB 113.76 billion in 1994, by far the biggest percentage increase recorded (see Table 8.2).
Bond trading volumes rocketed upward in 1995 as investors reacted to the fact that the first set of indexed bonds, maturing in July 1995, were set to pay out more than 25% - based on the official inflation adjustment of 13.01% plus a base interest rate of 12.2%.[130] The largest trading volumes were seen in the futures market, apparently fueled by widespread short-selling by brokers who had been caught on the wrong side of the market and were suffering severe losses from the ongoing advance in indexed bond prices. One particularly vigorous attempt to drive down prices is described by Poon, Firth, and Fung (1998, p. 208):
On February 23, 1995, an attempt by a Shanghai broker, Shanghai International Securities, to drive the futures market down by enormous short-selling closed the futures market amid chaos. Trading on this contract surged more than tenfold to nearly 100 billion yuan.
The authorities terminated all futures trading in government securities on the Shanghai Stock Exchange in May 1995. Following this step, total futures market turnover steadily declined from RMB 10,057 billion in 1995 to just RMB 1,608 billion in 2000 (Organisation for Economic Co-operation and Development, 2003).
Concerns about short-selling by securities firms also led the government to ban all commercial bank lending to such companies in August 1997, while further outlawing any participation in stock market trading by the commercial banks themselves.[131] Since that time, although the government has sold about 25% of its new bond issues via the stock exchanges (Bottelier, 2007), the larger portion has been sold through the interbank market.
After its establishment in 1997, China’s interbank market was expanded to include both financial and nonfinancial institutions. The role played by nonfinancial institutions has remained small, however, accounting for only about 6% of total bond issues going into 2006 (Hale, 2007). The Governorofthe People’s Bank, ZhouXiaochuan (2006a, p. 7), characterizes the interbank market as having “little regulation, and institutions are free to participate and strike deals at the prevailing market prices.” The growing liquidity of the interbank bond market, and the increasing stress on the trading of central bank bills, was discussed in Chapter 4. The expanding range of debt instruments also includes subordinated debt issued by commercial banks, asset-backed securities, and short-term corporate bonds (see Bottelier, 2007).Although government bond issuance has steadily expanded since the early 1990s, reaching RMB 704.2 billion at the end of 2005, the RMB 2,877.40 billion stock of outstanding public debt shown in Table 8.2 was still relatively modest - representing only approximately 18% of China’s overall 2005 gross domestic product (GDP). Corporate bond issuance, meanwhile, was still below 1992 levels as recently as 2004. One barrier to further development of this market has been the limited access to bank credit hitherto enjoyed by China’s private sector (see also Chapter 7). This restriction has left most private firms with “no means of developing a reputation for repayment that is essential for borrowing from the bond market” (Hale, 2007). Moreover, tight regulation by China’s National Development and Reform Commission (NDRC) kept most firms from entering the market at all. The NDRC set the price and issue date of each issue using a quota system and required that all bond issues be underwritten by the state-owned commercial banks. Other problems included a lack of information disclosure to potential investors and inadequate protection for creditors under existing bankruptcy laws (Zhou, 2006a, p.
8).Corporate bond issuance accelerated rapidly in 2005, however, rising from RMB 32.7 billion in 2004 to RMB 204.65 billion in 2005. This rise occurred as the People’s Bank established a new market for short-term corporate paper, with maturities limited to no more than one year, which began interbank trading in 2005. In the first six months, RMB 160 billion of these new instruments were issued and the total reached RMB 300 billion in 2006 (Anderlini, 2007b). Draft rules published in June 2007 potentially laid the foundation for still more rapid expansion in China’s nascent corporate debt market. A transfer of regulatory control from the NDRC to the China Securities Regulation Commission was to “do away with any kind of quota, allow bond prices to be set by the market, lay out clear criteria for issuance and require bonds to be backed by assets of the issuing company” (Anderlini, 2007b, p. 21). These new rules could well lead to a dramatic expansion in China’s corporate debt market in the future.