The Development of the China Bond Market - Essay Example

THE DEVELOPMENT OF CHINA BOND MARKET By Foundation Department Table of Contents Table of Contents 2 Introduction 3 Discussion 3 The development of Chinas bond market 3 Domestic government bonds 4 Corporate bond development 5 Probable remedies 6 Critical Issues for Future Development 6 Future Outlook 6 Conclusion 9 References 10 The Development of China Bond Market Introduction Economists argue that China is entering a new level in its development. This is assured by the fact that the country has shown remarkable economic growth over the recent past. As it is the case with other countries enjoying the same, the economic growth boosted the country’s wealth, which helped increase investment rates and possible financing for future growth. The county’s equity market has growth by a considerable margin with its great unpredictability and institutional organization attracting notable attention (Tong, 2005, p. 271). Economic analysts have argued that the bond market, whose role in the economic development is as great as that played by equity market has for a while remained obscure, as the general public seems to have little of it. Currently, few private investors are taking part in the bond market as compared to those in the stock market (Wu, 2014, p. 484). Worth noting, bond market plays a critical role in the economic development of a country, with the cash flow it provides playing a vital role in promoting the maturity of the individual investors assets and liabilities, and in the long run helping in the management of risks. As such, this paper will provide a detailed discussion of the development of the Chinese bond market, and provides an insight into the critical issues for future development. Discussion The development of Chinas bond market China began issuing treasury bonds in 1981 when it was first allowed to trade over numerous counters leading to the development of the secondary market for RMB Bond. The establishment of the Chinese stock exchange market in the 1990s led to the centralized trade of the Treasury bond. This piece of work analyzes the development of Chinese Bond market, which due to the absence of the centralized Securities Depository and not limited to inappropriate infrastructure has been hit by serious strikes. China is putting efforts to build a safe and cost effective bond market, which has led it to a healthy growth to emerge as one of the biggest financial markets in China (Zhu and Martha, 2009, p. 56). The bond market plays a significant role in the determination and setting of the fiscal policy and the monetary policy in China to sustain the financial revolution. In an effort to build a safe, low cost and efficient bond market, the establishment of the China Government securities Depository Trust and clearing company was a big boost (Guizot, Armelle 2012, p. 64). The CDCC (China Depository and Clearing Company) was the custodian of any marketable RMB bond and also began the development of open market operation systems which provided a platform for enhancing issuance of bonds not excluding government bonds and the bills of the central bank. The Debt Book-entry system of CCDC linked with the largest value funds transfer system that was established by the PBC to facilitate real time transactions and settlements. This improved the efficiency of operations as this was further linked to the China Foreign Exchange trading center systems. These infrastructural developments have indeed helped China bond market attain international standards (Neftci & Menager-Xu, 2007, p. 159). Domestic government bonds China had high dependence on foreign financing of bonds with limited participation of the domestic bonds. This was due to the unwillingness of the Qing to borrow from the citizens coupled with ignorance in understanding the modern finance in addition to little interest in investments in these bonds. Bond market develops well with a strong government, which will enforce contracts relating to borrowing and even being the major borrower by itself. Governments need to abide by the market rules and transact as a participant. This equality will ensure the credibility of the government and the market (Noble, 2015). Corporate bond development China had an underdeveloped corporate bond which has negative impacts on the economy’s financing structure and thus posing challenges to economic stability and social development. These challenges stem back from past mistakes, which, among others, are not limited to the quota allocation mandated by the central government which relieved the financially distressed firms (Rhee & Ghon, 2010). The investors were not rated for their credit worthiness and thus probable risks were not evaded. In addition, the investors operated with lack of information owing to the fact that the audit standards and external accounting were inadequate and there was no regulation of the disclosures that were made to them. The pricing of the bonds by the administrators did not put into consideration the likelihood of risks by the issuers and the investors. As before and even today bank guarantors were necessary to the authorities (Neftci & Menager-Xu, 2007, p. 159). Corporate bonds were targeting retail investors since they were capable of risk assessment as opposed to institutional investors. Market discipline that was necessary for the issuance of corporate bonds and their trading was not sufficient as manager exercised their judgment giving rise to problems. This was heightened by the fact that there was limited investor education. Any defaults that could arise were turned to government agencies for redemption (Noble, 2015). Probable remedies China can easily run away from these problems by moving the focus of their strategies from the central planning to concentrate on the market forces. The bond market will be effective if the allocation of quotas and administrative approvals were to be minimized. Secondly, the issue of corporate bonds should aim the right investors on the appropriate trading platform not neglecting the qualified institutions that would like to borrow and other over the counter (OTC) markets in order to strengthen the capabilities of managing risk. This will further enforce market discipline and streamline administrative controls over potential risks (Scott and Irene, 2006, p. 71). As a result of china’s immense economic growth, major world’s investors seek access to its bond market despite various potential hurdles such as limitations on who is eligible to invest and how to how to invest coupled with inadequate information on various bonds available. Regardless of such challenges, china has an increasingly large and diverse market ranging from private to public debt. In effect, china’s market bond is currently ranked among world’s largest coming third at around USD 4 trillion (Tong, 2005, p. 277). Critical Issues for Future Development Future Outlook In reviewing the critical issues for future development of the Chinese bond market, it is critical to evaluate the current position of the market, as it will give insight on the future expectations. Currently, the magnitude of the outstanding bonds is not small in reference to the current size of the country’s equity market. However, policy makers and practitioners seem to agree on one thing that there is less participation and hence illiquidity in the bond market. As it has always been with other security markets, to have this market developed, there is the need of a broad investor base, that in it there are diverse prospect and beliefs, and utility functions. This will encourage the trading between the counter parties (Tong, 2005, p. 275). It is worth noting that the current prevailing traditional economy in china, there is a high chance that the development of the bond market is highly competed by the equity market as well as the banking sector. In such a case, it is worth to not how government officials and corporation and private entrepreneurs perceive equity financing as a cheaper and better financing platform as a result of the right offering enjoyed by public companies, the minimal government regulations prevailing and the freedom not to pay for dividends. These are unavoidable challenges for future development. As such, there is a need for regulators to provide with the necessary education to the market regarding the mechanisms of operation on top making bond market available to issuers and investors (Neftci & Menager-Xu, 2007, p. 151). From the above overview, the development of the future role of China Bond Market is quite evident. It is further evident that the Chinese government is putting efforts to fasten the growth of its domestic bond market. PBoC, and other Chinese regulation bodies have vowed to support the market in the coming times, which will in effect allow key market players more power of rolling out new products. This will also help the players introduce more bond products, improve the current infra-structure and help in the facilitation of bond transactions (Wu, 2014, p. 484). When the bond market has fully developed, companies that look forward to raising their capital will be provided with other channels to do so. Once these developments take place, specific areas in the bond market will be promoted. Both municipal and local government bonds will be enhanced in a way that the municipality will impact highly in increasing of the capital necessary the county’s urban infrastructure development. The local governments are mandated to take up infrastructure projects, though not at all times the projects are net-asset-value. In such cases, private investors and municipal bonds aid the local government to reduce their financing cost by the provision strong tool for elasticity in financial management. These and other motivators assure for the corporate bond market development, promoting it to be ranged a assuring area for the entire county’s bond market (Tong, 2005, p. 256). On the other hand, secondary market development stands out as a requisite element int eh market development. There is the need for effective communication to relay the necessary information, as this is made possible through the secondary market. In the absence of this, it is possible to lack liquidity necessary in the rebalancing of the portfolio and the controlling of risks (Neftci & Menager-Xu, 2007, p. 153). With assured future development, there are merits that will come along with it. To begin with, there will exist a huge demand infrastructure improvement and residential development in the near future. With has encouraged the security from international practices, acting as a sure way to attract private investors (Tong, 2005, p. 266). With a successful securitization of bank loans, the entire banking sector distances itself from infrastructure financing through loans hence reducing the risk that come with the loan portfolio. What this means is that the entire banking sector stabilizes fully. Secondly, securities that are backed by assets offer bonds that do not have same credit rating. This helps investors to come to a better understanding of credit risks eventually initiating credit rating agencies development (Wu, 2014, p. 486). In essence, the future of the Chinese bond markets offers greater opportunities as it will promote corporate bond, giving corporations and private enterprises new financial channels. However, to ensure that the market plays is paramount role, there is need to ensure a strong legal system that is properly regulated and build following the right steps. First, is good to ensure a legal protection to the involved. The standards of corporate governance need to be assures as well as action within the international accounting standards. This will assure a unified and simplified prerequisite for participation in the primary market. To attain this, all key stakeholders who include market regulators, investors and market intermediaries should attentively act upon the Chinese bond market to assist the market in reaching its expected full potential. Conclusion This paper has provided detailed analysis of the historical lessons, an explanation to the existing challenges, as well as Chinese bond market future prospects. Evident though, the market has a potential for growth in the near future. Further, the current situation confirms the fact that both legal and political conditions have played a notable role in the process of shaping the bond market. As such, China’s bond market has boosted the economic growth to commendable level, making china one of the world’s best economies. From the current state, it is evident that the country is giving the bond market a bigger responsibility in financing and pricing part of the world’s economy (Sun, 2014). Ideally, it is speculated that this market grows, offering greater potential in the coming years. There is need for reforms in both legal and political arenas as such reforms are a sure way to developed bond market fueling possibilities of future healthy economic growth. All key players in this market should actively participate in the Chinese bond market, giving the market a great attention and try all means possible to assist the market realize its full potential to the country. References Guizot, Armelle (2007), Chinas Economy: Financial and Banking System, Foreign Exchange and Interest Rate Risk Policies, Harriman House Publishing. Neftci, S. N., & Menager-Xu, M. Y. (2007). Chinas financial markets: an insiders guide to how the markets work. Oxford, Academic. Noble, J. (March 2015). China’s bond market passes property test. Capital Market. Accessed on 30 April 2015 http://www.ft.com/cms/s/0/97d9a7ca-d1fa-11e4-a1a0-00144feab7de.html#axzz3YojshYGD Rhee, S. & Ghon, 2010, “Regionalized Bond Market: Are the Region’s Market Ready?” Working paper, University of Hawaii. Scott, D. H. & Irene S.M. Ho, 2006, “China’s Corporate Bond Market, 2004,” The World Bank. Sun, H. (Nov 2014). China Expands Access to $4.3 Trillion Interbank Bond Market. Bloomberg. Accessed on 30 April 2015 http://www.bloomberg.com/news/articles/2014-11-03/china-expands-access-to-its-4-3-trillion-interbank-bond-market Tong, X. (2005). Financial services in China: the past, present and future of a changing industry. Singapore, China Knowledge Press. Wu, X. (2014). Chinese securities companies: an analysis of economic growth, financial structure transformation, and future development. Zhu, Jinqing C. and Martha A. (2009), Chinas Emerging Financial Markets: Challenges and Global Impact (Wiley Finance), John Wiley and So Read More