CHINA’S recent moves to ease credit conditions were supposed to support struggling private firms, but investors, spurred by easier cash, are instead pumping money into low-rated bonds issued by State-backed entities.

The People’s Bank of China this month injected money into the banking system and encouraged banks to buy lower rated corporate bonds as part of attempts by the government to throw a funding lifeline to the private sector in a slowing economy.

However, bond markets data shows the persistence of a stubborn preference for the debt of local government financing vehicles (LGFVs) and State-owned enterprises (SOEs).

Despite government messages to contrary, investors believe such assets are less risky owing to implicit government support.

Samuel Wang, an official at China Zheshang Bank’s asset management department, said bonds issued by private firms would represent just “a small portion” of the bank’s portfolio.

According to the lender’s disclosure, instruments issued by corporates account for merely 1.4 percent of its 562.7 billion financial investments, which are heavily concentrated in debts issued by the government and financial institutions.

Such a bias, already reflected in rapidly falling yields in LGFV and SOE bonds recently, could mean resources continue to be channeled into China’s inefficient sector at the cost of private firms that contribute to 60 percent of China’s economic growth and over 80 percent of new jobs.

“It’s a paradox. Private firms were hurt by the deleveraging campaign and the government wants to help them. But for market players, the rational choice is to invest elsewhere,” said Zhou Li, president of the bond-focused asset manager Rationalstone Investment.

If the private sector continues to suffer from a funding shortage, China’s long-term economic growth could suffer, he said. Yet Zhou’s firm, which gets mandates from banks, also shuns risky corporate bonds issued by private firms.

Private Chinese firms have long struggled to tap the largely State-dominated financial system, and many have resorted to shadow banking and other channels for funding in the past.

But the funding environment worsened rapidly in the first half of this year as the Chinese Government stepped up efforts to reduce risky loans. A series of defaults also soured investors’ appetite for corporate bonds. (SD-Agencies)