Domestic factors drive China’s credit outlook amid heightened uncertainty

On February 24, Russian forces launched a military attack on parts of Ukraine. Since then, numerous Western nations have responded by imposing a range of sanctions on Russia.¹ We assess the event’s impact on China’s credit markets and outline why we believe that the effect on investment-grade credits is currently limited and that domestic factors are largely driving the outlook for the high-yield segment.

Image of a person walking on the Great Wall of China, with scenic hills in the background

Although the Russia-Ukraine military conflict has sent tremors throughout global markets, the impact so far on China credit has remained minimal. 

Geopolitical events such as war are extremely fluid, with broad and rapidly shifting implications for economies and markets. The most immediate impact of the ongoing conflict and associated sanctions against Russia is the fear regarding supply shortages of energy, grain, and metals globally. The absence of the Russian supply of fertilizers may result in a long-term decline in the supply of agricultural products, or a food crisis. High—and rising—commodity and food prices could push the global economy further into stagflation territory and weaken the recovery from the pandemic. 

China, as a voting member of the United Nations Security Council and its closer diplomatic relationship with Russia, will inevitably be affected by recent developments. Chinese companies may be directly affected by rising volatility and prices in the commodity markets as Russia is a key producer and exporter of energy and rare earth metals. In addition, offshore funding could be hindered as capital markets are disrupted by geopolitical events; however, economies such as China—with stronger balance of payments, robust current account surplus, and foreign currency reserves—may prove to be particularly resilient against these potential shocks.  

Investment-grade credits: sectors to watch

Overall, based on the current situation and number of sanctions imposed on Russia, we don’t yet see a negative impact on segments of China’s credit market, although this assessment could change. In our view, investors should keep their eyes on two important sectors in the investment-grade space: financials and energy.   

Financials: China’s financials sector has limited direct exposure to the Russian economy, or to financial counterparties in Europe, which may experience a weakening in their capitalization and liquidity position. The decision to remove Russian banks from the SWIFT financial messaging network doesn’t affect China directly, and domestic financial institutions may undertake efforts to develop an alternative system with Russian institutions, while strictly adhering to the current sanctions regime.  

Energy: China has broader energy ties with Russia, including a recently signed 30-year agreement for natural gas delivery.  Some state-owned firms also have minority stakes in Russian liquid natural gas projects.2; however, the country isn’t overdependent on Russian energy imports and still has a diversified energy base and rich domestic coal deposits.

Since energy isn’t currently included in broader sanctions (although the United States has banned Russian oil, liquid natural gas, and coal exports), we believe the exposure of Chinese energy companies is limited. Furthermore, capital raising activities aren’t likely to be adversely affected as several prominent state-owned companies are already on U.S. sanction lists.  

Latest assessment of China high-yield market

The outlook for the high-yield space remains challenging due to the country’s real estate sector. Although some high-profile large developers defaulted in December 2021, the amplified financial distress caused by those events has led to weaker sentiment and reduced liquidity, judging from the several distress cases in January and the latest February contracted sales data.

This, in turn, has negatively affected stronger and higher-quality developers (from “BB” to “B” rated) that previously were thought by investors to be less risky. This phenomenon is also starting to seep into the stronger onshore credit market, leading to more volatility. We believe more defaults of high-profile names could materialize soon. 

These developments broadly align with our original thesis that the rebound of the real estate sector will be gradual. The sector will take several years to deleverage and transform into a right-sized, more financially stable and commercially viable industry.  

Domestic factors drive China’s high-yield market outlook 

In the meantime, we’ve seen some positive developments since our last update in government policies, although more support might be needed. The People’s Bank of China adopted a more accommodative monetary policy stance since December 2021, having lowered the one-year loan prime rate by five basis points (from 4.65% to 4.60%) as well as the mortgage reference rate. Locally, mortgage rates in nearly 90 cities have been reduced to help cushion the downside and several cities have relaxed down payment rules to boost affordability for home buyers.

Moving forward, we believe investors should pay attention to three key catalysts in the short to medium term: 

  • Trajectory of contracted sales and consumer confidence—This metric represents the number of sales for developers and serves as a rough proxy for consumer confidence and the health of the industry. While we haven’t seen a turnaround yet, this can be a leading indicator that should show improvement when it comes.   
  • Continued government policy support—Although central and local governments have begun to provide policy support, we believe further targeted backstop measures could be unveiled in the coming months to improve liquidity and incentivize consumers to purchase real estate.
  • Restructuring of existing defaults/distress—Although numerous property developers are already in technical default, or on the precipice of defaulting, there’s still limited visibility on the haircut that creditors will ultimately take. We expect the restructuring discussion to take longer than a year, but note that the size of the potential haircut could serve as an indicator for sentiment to recover, particularly if it’s smaller than currently expected. And as the restructuring process progresses and these uncertainties are addressed, we expect more market participants to enter the market to acquire assets. 

The importance of robust credit selection in volatile markets

As the speed and volatility of recent geopolitical events illustrate, we believe robust research and due diligence is paramount in credit selection. Many of the risks in the current environment are due to economic linkages that may not be apparent from cursory analysis. Indeed, our bottom-up credit research includes careful examination of company fundamentals, including customer concentration and cash flow sources as well as stress tests of potential punitive actions, which carefully inform our investment decisions.  

 

A raft of sanctions, including on the Central Bank of Russia and other Russian banks, as well as access to global payments systems and high-tech equipment exports. Bloomberg, March 12, 2022. 

Disclaimer

A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment

Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments.  These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments. 

The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.

This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.

Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here.  All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice.  This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results. 

Manulife Investment Management

Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.

This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional

Australia: Hancock Natural Resource Group Australasia Pty Limited., Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland. Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad  200801033087 (834424-U) Philippines: Manulife Investment Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited. 

Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

550787

Fiona Cheung

Fiona Cheung, 

Head of Global Emerging Markets Fixed Income Research

Manulife Investment Management

Read bio
Judy Kwok

Judy Kwok, 

Head of Greater China Fixed-Income Research

Manulife Investment Management

Read bio