Faced with slowing economic growth, we believe Beijing has shifted its focus away from tackling the country’s medium-term structural problems. The priority now, in our view, is supporting the economy, including the debt-ridden property sector where construction activity and property sales slumped after the imposition of stricter controls.
While we do not foresee a U-turn, we believe policy support for real estate developers is likely to increase.  This should lead to a normalisation of the credit spreads for both Chinese real-estate bonds and the broader high-yield debt market in Asia. This, we believe, creates an attractive investment opportunity.
Policy shift to ease property sector stress
Given the Beijing’s new policy stance, we expect the contraction in real-estate activity to lose momentum in the coming months. Moderate policy stimulus and further tweaks to, but no wholesale reversal of, the property market controls should bolster the sector.
A number of city and provincial governments aim to promote property sector activity. In addition, the People’s Bank of China (PBoC) has called on banks to support the sector by extending loans to developers allowing healthy firms to acquire projects from those who are struggling.
Up until now, the measures announced are insufficient to resolve the problems in China’s property markets. For the moment, Chinese policymakers are hesitant to loosen controls substantially. We anticipate the growing risk arising from the spread of Omicron in China will convince officials to act more decisively.
We are not predicting a repeat of the massive policy easing seen in 2015/16. Instead, we expect a raft of policies aimed at keeping developers afloat by increasing their financing and boosting their cash flows. Relaxing the controls should also allow the sector to benefit more from the broader monetary easing that we see as being necessary in the coming months.
Potential triggers for further action by policymakers include persistent weakness in property sector data, signs of stress in related sectors such as steel and cement and/or a further deterioration in market sentiment that might lead to instability in financial markets.
We may see major policy adjustments as soon as at the annual meeting of the National People’s Congress on 5 March. 
China real estate – Pricing a worst case scenario
Over the past year, emerging market high-yield corporate bonds underperformed their US and EU peers (both of these segments delivered positive returns). This underperformance was mainly driven by Asia high-yield (HY). Looking at the individual sectors, the EM real-estate sector (dominated by Chinese issuers) posted significant underperformance.
In the short term, we expect the China real-estate sector to face headwinds. These may arise from some developers encountering weaker sales and further refinancing and/or negative headline risk as sentiment towards the sector remains weak.
The challenges include pressure on the liquidity position of developers, with cash inaccessible for debt repayment, and most refinancing channels effectively closed due to heightened borrowing costs. Housing sales have been sluggish. To replenish liquidity, developers are having to dispose of assets.
We believe HY Chinese property sector bonds have priced in a worst-case scenario reflecting an implied default rate of 26%. We expect the actual rate in 2022 to be significantly lower. Our expectation is based on China’s authorities implementing supportive policies to allay concerns over economic growth and the health of the real estate sector which contributes about 30% to the country’s GDP.
We acknowledge idiosyncratic risk as a key risk to our view. Solid credit fundamentals are of great importance in this environment – developers with better metrics in terms of a cash buffer, sales performance, multiple revenue sources, strong shareholder support and potentially easier funding access will fare significantly better than weaker players.
We expect Chinese policymakers to draw a line in the sand and ensure that the sector can weather the storm while allowing overextended issuers to default.
The property market will likely enter into another round of market consolidation, enabling quality developers to recuperate the market shares of distressed peers.
We believe we are at a turning point in terms of valuations. In the medium term, we expect a significant level of normalisation. We realise this is a contrarian call.
Asia credit – Current valuations look compelling
The current level of spread differentials between Asia and US HY makes Asia HY valuations look attractive.
Versus its EM peers, Asia HY admittedly has weaker metrics, specifically higher net debt and short-term to total debt ratios. While we acknowledge the fundamentals might not look as strong as those in other regions, this is nothing new. We believe that given the current level of valuations, extreme pessimism is unwarranted.
Current credit spreads within Asia HY appear attractive, particularly to high-conviction investors such as us. We also see Asian investment-grade (IG) debt as attractive relative to other emerging market and developed market IG. Scope for attractive returns arises from the current level of valuations for Asian HY debt and the potential for spread compression under our central scenario.