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Photographer: Qilai Shen/Bloomberg Photographer: Qilai Shen/Bloomberg

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Closer linkages between China’s onshore and offshore bond markets are threatening to spread contagion from local defaults.

As the nation’s economy slows and liquidity tightens, its weakest companies are facing repayment woes. This, in turn, is creating jitters offshore. Growing participation by Chinese investors in the dollar bond market has led to concentration risk, with such buyers now dumping their holdings at the first hint of trouble.

Asian junk notes -- the majority of which are from Chinese issuers -- suffered their worst losses last week since August, as a string of onshore nonpayments doused cold water on a rally.

A distressed exchange offer by state-owned commodities trader Tewoo Group Co., often considered a de facto default by foreign rating companies, has prompted onshore investors to lose confidence in government support. Adding to this, a local government financing vehicle missed an early local note repayment on Friday, reviving broader concerns about such borrowers, even though it was able to make payment Monday.

With nearly a quarter of the total of Chinese dollar bonds outstanding due to mature next year, fears are mounting.

Great Wall of Debt China borrowers face mounting debt maturing in 2020 Source: Bloomberg-compiled data



Chinese investors previously anchored credit worthiness of state-owned enterprises and local government financing vehicles to “strong convictions” the government would support them, said Zhi Wei Feng, senior credit analyst at Loomis Sayles Investments Asia.

Now, this faith has been eroded, she said. Local investors, who were at the forefront of the rally when they were bullish, are leading a decline as confidence falls, Feng added.

Read more: China’s $17 Billion Default Wave Is About to Break a Record

A missed local note payment for top university Peking University Founder Group has prompted the company’s offshore bonds to slump amid fears of a cross-default. A wave of debt due for early repayment onshore is also causing financial stress among borrowers.

“There’s definitely a worry that if we see more stress on issuers in the onshore market, it will spread to offshore,” said Christopher Lee, managing director of corporate ratings at S&P Global Ratings.

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