Fact or fiction: Implicit government guarantees in China’s corporate bond market

• Published in: Journal of international money and finance 2021-09, Vol.116, p.102414, Article 102414
• Main Authors: Walker, Thomas, Zhang, Xueying, Zhang, Aoran, Wang, Yulin
• Format: Article
• Language: English
• Subjects: China; Corporate bonds; Emerging markets; Implicit government guarantees
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2021.102414

•We study the effect of implicit government support on bond yield spreads in China.•“Chengtou” bonds issued by LGFVs carry implicit government guarantees.•Chengtou bonds are less risky than bonds issued by market-oriented companies.•Recent government policies attenuate the implicit government guarantees. This paper explores how implicit government guarantees affect the yield spreads of Chinese corporate bonds. We argue that quasi-municipal corporate bonds (“Chengtou” bonds), issued by local government financing vehicles (LGFVs), carry an implicit government guarantee and therefore enjoy a reduced yield spread. Using a sample of publicly traded corporate bonds between 2010 and 2017, we show that bond investors are significantly less sensitive to bond-specific risks for corporate bonds with an implicit government guarantee: the yield spreads of Chengtou bonds are significantly lower than those of corporate bonds issued by privately-owned enterprises (POEs). Furthermore, we find that policy changes introduced by China’s central government, which were intended to regulate local governments’ debt financing activities, significantly reduced the gap in yield spreads between Chengtou bonds and bonds issued by POEs. Overall, our results suggest that implicit government guarantees play a crucial role in China’s nascent corporate bond market, but that the country’s recent policy changes have reduced the effectiveness of such guarantees, making China’s corporate bond market more market-oriented.