China Poised to Issue Junk Bonds

Nine-Star Technology, which makes and sells financial capital software, is just a dozen years old, but it already dominates half the market for this kind of software. Xie Hongguo, Nine-Star Technology's founder and president, said the company's still growing, at about 30 percent a year, and it needs capital to fuel that growth.

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He was quick to sign up when he heard China would be allowing the country's first junk bonds to be issued in June.

"This is great news for small and medium enterprises," Xie said. "Before, when companies like us needed to get capital, there were only two ways."

One way was to issue stock, which effectively means giving up a share of your company. The other was going to banks, which often requires physical collateral that a software company generally doesn't have.

"When neither of those would work, we would go to loan sharks," he said, "which is burdensome, and very, very dangerous."

The loan sharks, or shadow banks, charge interest rates that average around 21 percent – and it's not pleasant for borrowers when they don't pay back on time.

Nine-Star Technology just issued its own junk bonds, paying 8.5 percent. Xie said that's slightly more interest than the company would pay on a bank loan and you don't have to jump through as many hoops.

"I would say this junk bond is the first capital tool in the Chinese market that doesn't have to be approved by the government bodies. You only have to register. This is very interesting to us."

It's interesting to the Shanghai Stock Exchange, too. The exchange is light on private companies, despite the fact that the private sector accounts for an outsized proportion of China's GDP growth.

Start-ups and medium-sized companies grow especially fast, and need access to capital. Xia Jianting, the assistant to the president of the Shanghai Stock Exchange, said while only a few companies were allowed to issue junk bonds this month, the market's expected to expand fast.

"The market demand is very large. I think in a couple of years, the number of companies issuing junk bonds will outnumber the listed companies," he said.

But for now, Xia Jianting said, it's a cautious start. Junk bonds are not being traded publicly. They're only available to institutional investors worth at least $1.6 million, or individual investors worth half that. The idea is that investors should know the risk they're taking. But another idea, Xia said, is that the private sector get a boost, which in turn can boost China's long-term growth.

"We want some companies, after they issue the bonds, to become big and strong – maybe the next Apple or Microsoft."

It'll take more than issuing junk bonds to make that happen. Much in China's economy is skewed to favor state-owned companies. For all the talk of wanting to shift to a consumer-led economy, with a robust private sector, those within the government who are personally profiting from the status quo haven't been so quick to act yet, according to economist Nicholas Lardy.

"Vested interests have managed to stall reform over recent years, but possibly this combination of circumstances China is facing today will lead to more decisive action on the part of the new leadership when it comes in," Lardy said. "Nothing focuses the minds of those in power in this Party like the prospect of a sustained slowdown in economic growth."

A once-in-a-decade change in top Communist Party leadership is slated to take place this autumn.

Meantime, one government official told a conference of state-owned enterprise managers in June to prepare for what he called a 'long winter' – three to five years of slower economic growth.

The new junk bond market might help the more nimble private sector pick up the slack. Early results are encouraging. Nine-Star Technology's Xie Hongguo chuckled when asked how his company's issuance of junk bonds is going.

"We asked for $1.5 million," he said. "We sold out in less than a day."