As more companies in China are expected to tap the so-called virus bonds for quicker access to cheaper funds to survive the coronavirus outbreak, analysts warn that the country's credit risk may rebound.

The Epidemic Prevention and Control Bonds, announced Feb. 1, allow companies to launch new debt within days instead of weeks, on condition that at least 10% of the proceeds are used to "fight the virus."

As of Feb. 20, at least 33.51 billion yuan worth of virus bonds were issued, according to disclosures from Shanghai Clearing House and China Central Depository & Clearing Co. At least 28 companies, spanning a wide range of industries from banks, airlines and construction to healthcare and real estate, have issued 31 virus bonds so far.

Many issuers sold their virus bonds at coupon rates lower than their previous debt of comparable tenors, as the government has encouraged financial institutions to subscribe to the debt and that created demand to drive yields lower.

For instance, Xiamen Airlines Co. Ltd. on Feb. 12 priced 400 million yuan 177-day notes under the new program at 2.30%, lower than the 2.55% coupon it offered for 400 million yuan 176-day notes issued Nov. 27, 2019.

Unwinding deleveraging efforts

The virus bonds, alongside other measures to improve market liquidity, may further unwind China’s deleveraging efforts that started reversing last year amid trade tensions with the U.S. and slowing growth of the nation's economy, analysts said.

"Account receivables, short term debt more generally, will balloon," said Alicia Garcia-Herrero, Natixis chief economist for Asia Pacific. She added the Chinese government will have to step in to rein in default risk, which could rise if more virus bonds are issued in the near term.

S&P Global Ratings said in a Feb. 20 note that, in the worst case scenario, "questionable" loans in China's banking system could almost double as some companies and individuals may find it difficult to repay their debt if the outbreak continues.

However, some analysts are not too worried.

Iris Pang, Greater China Economist at ING Bank, believes the overall volume of virus bonds will likely be "limited" as the government may not want the market flooded with liquidity.

The bonds are "intended as a temporary relief measure for companies hit by the outbreak," Pang said. She added that the government will need to monitor the use of proceeds closely to prevent abuse of the new instrument, and policy stimulus of this nature must be "targeted, very focused" to prevent the economy from "fast releveraging," she added.

Expecting more easing measures

The epidemic has worsened the liquidity crunch already faced by Chinese companies. To cushion the shock to the economy, authorities implemented a wide range of measures to inject liquidity to financial markets and lower borrowing costs for companies.

The People's Bank of China lowered its benchmark one-year loan prime rate by 10 basis points to 4.05% on Feb. 20, shortly after it cut the interest rate on 200 billion yuan worth of medium-term lending facility for financial institutions by 10 basis points to 3.15% on Feb. 17.

"We expect further monetary easing in the coming weeks, both targeted and broad based, in an effort to shore up credit growth and economic activity," said Julian Evans-Pritchard, Senior China Economist at Capital Economics.

Corporate bond issuances and shadow lending activities slowed in January, Evans-Pritchard said, citing government data. The drag on credit demand may have intensified in February as more companies put investment plans on hold, he added.

S&P Global Ratings Feb. 7 cut its economic growth forecast for China to 5.0% for this year, from 5.7% earlier, assuming the virus outbreak will be contained by March and the economy may start recovering in the third quarter. The world’s second-biggest economy grew 6.1% in 2019, the lowest pace of expansion in 30 years. The agency expects China’s economic growth may rebound to 6.4% in 2021.

As of Feb. 20, US$1 was equivalent to 7.02 Chinese yuan.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.