By staff reporter Zhang Yuzhe

Beijing has approved a pilot project for a high-yield bonds market as part of the state initiative to facilitate financing for small and medium enterprises (SMEs).

The initial phase is expected to start in September and will allow SMEs to issue inter-bank notes to generate capital. This marks China’s first venture into the lucrative but high-risk junk bonds market.

At the helm on the new initiative is the National Association of Financial Market Institutional Investors (NAFMII), a state-backed trade association. While aiming to provide effective financing channels for smaller companies, the pilot project will test the waters of what is now a non-existent junk bonds market. At present, China’s market only offers high credit rated products with yields that differ little across the spectrum.

Caijing has learned that the SMEs selected to participate in the pilot project will be limited to companies with good performance records and high credit ratings. Thus, the scale of the initiative will not surpass 2 billion yuan. As one banker put it, “This will be equivalent in scope to the bond issuance of a single large corporation.”

Some speculate that the interest rate for SMEs in the short-term bonds market will be lower than the interest rate for bank loans in the same period.

“We need to watch our steps,” said a source from NAFMII. “But the purpose of launching a short-term financing project for SMEs is to explore the high-yield bonds market. We should pay special attention to how to set proper interest rates.” The source added that if violations occur, they will serve as indicators for seeing how mature the market is.

In 2008, under heavy inflation pressure, a tightened monetary policy, and with stock markets slumping, yields in the bonds markets will be an open question for investors. The current bond market is still at the preliminary phase of development, and high-yield corporate bonds and credit products are still severely deficient.