Rising corporate defaults do not pose a systemic threat to China

agosto 2016

The number of defaults in China’s onshore bond market has risen sharply recently. However, this trend should not pose a systemic risk with the government expected to keep refinancing costs down, according to Joyce Bing.

 

China’s debt now totals around 225 per cent of GDP according to the International Monetary Fund (IMF). While levels of government and household debt, both around 40 per cent of GDP, are relatively low by international standards, corporate debt represents around 145 per cent of GDP, a high level in global terms. Corporate debt in emerging economies averaged below 75 per cent of GDP in 2014, according to the IMF.

State-owned enterprises (SOEs) account for about 55 per cent of corporate debt, far greater than their 22 per cent share of economic output. SOEs are also far less profitable than private companies.

Around 90 per cent of China’s corporate bond debt is denominated in the local currency, the renminbi, and issued into the onshore bond market. SOEs are the major issuers in the onshore bond market, with local and central SOEs accounting for around 43 per cent of issuance. The next largest source of issuance, the central government and policy banks, each account for around 22 per cent of issuance. Some SOEs have been able to borrow more than was prudent because investors assumed that the government would provide support if they encountered financial problems. In other words, investors viewed SOE credit ratings as being equivalent or similar to sovereign ratings regardless of their standalone creditworthiness.

Deteriorating corporate finances prompt rise in debt levels

SOEs with high debt levels are now being hit by a combination of slowing economic growth, declining earnings and rising indebtedness. This is undermining the ability of companies to service their debts and pay suppliers, according to the IMF. Consequently, a number of SOEs are now in a weak financial position, with the IMF going as far as to claim that many “are essentially on life support”.

The rise in credit events over the past two years or so reflects this. In March 2014, solar panel maker Chaori Solar became the first Chinese firm ever to default on its onshore corporate bonds, while in April 2015, Baoding Tianwei, another solar company, became the first SOE to default on its bonds. By the end of June, 20 companies had defaulted including Dongbei Special Steel Group, the shipbuilder Evergreen, Nanjing Yurun Foods, and the solar group Yingli Green Energy. The April 2016 suspension of nine bonds issued by the AA+ rated China Railways Materials, the first of the big SOEs to signal default, caused particular alarm among investors. Between March 2014 and June 2016, there were 20 defaults in China with SOEs accounting for around 45 per cent of these defaults.

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In Summary

  • State-owned enterprises (SOEs) have been allowed to borrow more than was prudent because of their quasi sovereign status    
  • Many are now struggling as the economy slows and the government seeks to promote a more efficient allocation of capital
  • The government is likely to keep financing costs low at least until the end of 2018 
  • The level of defaults is likely to remain low and concentrated in declining sectors of the economy