China’s drowning in debt, defaults are rising and investors have turned bearish as corporates must pay back billions this year
China's massive debt levels have started to spook investors. The country’s corporate borrowers face a record $571bn of debt that’s due to mature this year, according to figures from Bloomberg. That’s cash they’ll either have to pay back or refinance.
Too bad, then, that sentiment towards local debt has begun to sour. There has been a rise in the number of firms defaulting on their debt. The tally for defaults so far this year is equal to the number for the whole of 2015.
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“Admittedly, the absolute number is still low at just seven. But defaults are a relatively new phenomenon in China. The first took place just two years ago,” explains Chang Liu of Capital Economics.
DEFAULTS
Corporate defaults are such a new concept that any potential ones spark a lot of hubbub. In 2014, a bond that had been offered to wealthy investors, called “Credit Equals Gold No. 1 Collective Trust”, was widely expected to be the largest default in a decade, after it lent money to a coal miner which ran into trouble.
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The saga sparked discussion of an impeding debt bubble bursting, but Credit Equals Gold was bailed out by an anonymous bidder, believed to be the People’s Bank of China.
Now Chinese authorities are allowing more struggling firms to miss payments, rather than stepping in to support them. “This has introduced a new source of uncertainty into bond markets,” says Liu.
As a result, there has been a widening in corporate bond spreads, meaning borrowing costs are higher for businesses.
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Although investors have expressed more caution towards local corporate bonds, the data isn’t indicating Armageddon just yet. Borrowing costs are higher, but they’re still low relative to history.
There’s also been talk of companies cancelling plans to refinance their debt, because of a lack of investor demand. That may show the inklings of a new trend beginning. But fears investors will stop financing bonds altogether are overdone. There isn’t a widespread lack of financing, says Liu.
BANKING TROUBLE
China’s debt problems are a story that’s going to keep running. Since 2007, the country has added $21 trillion of debt, and it hit a record high recently. Debt now stands at 237 per cent of GDP, according to Financial Times calculations.
“I thought they would be taking their foot off the accelerator with the debt but they haven’t done that. It has increased dramatically in the last six to 12 months,” says Roddy Snell of Baillie Gifford.
It will be a big problem for the country's state-owned banks at some point. “It’s going to be very negative for the banks. Someone is going to have to pick up the tab and it will fall on the banks,” Snell adds.
He says much of this debt has failed to find its way into the productive economy. “The problem with debt in China is that we are not sure where a lot of the money has gone. It seems to have gone to local authorities’ bank accounts and not into the economy.”
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RISING DEBT
The Chinese economy was hurt by the global financial crisis, especially in terms of weakening demand from the rest of the world. Rather than pay down its debt, Chinese authorities have allowed huge amounts to build up.
“By building up a debt pile, [policymakers] bring forward the next 20 years of growth,” says Richard Maitland of Sarasin and Partners.
Recent data out of China shows the economy is still treading water. GDP growth for the first quarter was 6.7 per cent, only slightly below last year’s 6.9 per cent. The fact there is still growth, albeit not as fast as before, is down to an “exceptional rise in credit”, says Miranda Carr of Haitong Research.
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It’s because the amount of growth that each new dollar of debt is generating has been declining, says Luke Spajic of Pimco. “Leverage will continue to rise, but its ability to generate new growth is diminishing,” he says.
In other words, “China’s ever decreasing economic efficiency means that ever more debt has to be piled into the economy just to stand still,” says Carr.
She pinpoints June as a time when this could potentially become a much bigger issue. “A combination of a seasonal, end of the second quarter, interbank squeeze in China, alongside a large credit default and a US interest rate increase, would bring all this to a head in June 2016, unless there is some heavy central bank intervention.”