Shaun Roache, IMF resident representative in Hong Kong, said the new NSSF policy may be partly aimed at widening the pool of municipal bond buyers and ensuring yields do not rise too far. But it also makes it less likely that Beijing would allow municipal bond defaults, since that would swallow up taxpayers' social security funds.
In China's tightly administered bond market, most companies allowed to issue bonds tend to have some form of state backing, so corporate bond yields fell sharply in response to the news, with AA and AAA-rated bond yields declining around 15 basis points, the sharpest downward move since a surprise interest rate cut in November 2014.
On Tuesday came further evidence that bond investors are not losing sleep. When Chinese internet firm Cloud Live Technology defaulted, bond yields hardly moved, in stark contrast to a year earlier, when a first public default by Chaori Solar caused a sharp spike.
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Chaori Solar was bailed out a few months later with the help of local authorities, leaving investors to conclude that if the Chinese system can't stomach the collapse of even economically insignificant firms, there is little likelihood that local governments and linked companies would be allowed to fail.
Allowing the NSSF to buy into local government debt reinforces that conclusion.
"The government has formally agreed to back the debt of these local governments and their affiliated companies. That, from the perspective of analyzing credit risk, is a bad thing," said an investment manager at a major joint venture fund that buys Chinese stocks and bonds.
Markets have, moreover, continued to price Chinese municipal debt and sovereign debt as virtually identical.