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China's bond market is 'overheating' after stocks, survey says

China's stocks rose, paring the biggest quarterly loss since 2008, as the government struggled to halt a US$5 trillion rout and the world's second-largest economy showed signs of a sharper slowdown.

[BEIJING] The bursting of China's stock-market bubble has scattered money into corporate bonds, causing them to overheat, financial companies surveyed by Bloomberg say.

Nineteen of 21 respondents said the credit market is "overheating," according to the survey sent to onshore analysts, traders and fund managers. Some 60 percent forecast corporate bond yield premiums will widen in the fourth quarter. That would mark a shift after the difference between five-year AAA company securities and government notes dropped to a six-year low of 83.6 basis points on Sept 7.

"The stock rout has driven a lot of capital into the bond market," said Shi Lei, the head of fixed income research in Beijing at Ping An Securities Co, a unit of China's second- biggest insurance company. "Even though there's no such sign at the moment, I'm concerned what will happen if there is a shift in central bank monetary policy or a rebound in stocks.

Chinese companies are reveling in the lowest borrowing costs in more than six years after the People's Bank of China cut benchmark interest rates five times since November. The central bank's easing comes amid the slowest economic growth in more than two decades, and in the aftermath of what Governor Zhou Xiaochuan called a "burst" equities bubble.

Cheaper money is also a lure. "Most investors borrow three to 10 times their original investments to boost returns," meaning any fallout later could be worse, according to Ping An's Shi.

China Vanke Co, the nation's third-biggest developer, sold five-year AAA rated bonds on Thursday at 3.5 per cent, a lower yield than notes issued by China Development Bank Corp, the biggest of the three policy banks that have quasi-sovereign ratings.

"Chinese companies' credit profiles are still worsening," said Jiang Chao, a bond analyst at Haitong Securities Co. in a report Friday.

Money Exits China has already had three domestic bond defaults this year including Baoding Tianwei Group Co, a maker of electrical transformers that reneged on payments in April, becoming the first state-owned company to default. It said earlier this month it's filing for bankruptcy or restructuring.

Huachuang Securities Co. said in a report on Sept 22 that bubbles are piling up in the corporate bond market because many banks' wealth management product accounts have to use leverage to increase returns. Industrial Securities Co. also warned in a report e-mailed Sept 23 that the flow into domestic bonds could pose the risk of a bubble.

Money is leaving China faster than ever following the central bank's yuan devaluation in August, according to a Bloomberg gauge tracking capital flows. An estimated US$141.66 billion exited China in August, exceeding the previous record of US$124.62 billion in July, data compiled by Bloomberg show.

"Risks on corporate bonds may arise if inflation grows faster than expected and there are more capital outflows driven by yuan weakening," Zhou Hao, a senior economist in Singapore at Commerzbank AG, said.