Last updated: 12:50 / Thursday, 13 October 2016
Says Investec

China: Inflated Credit, Rising Defaults

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China: Inflated Credit, Rising Defaults
  • Credit growth is outstripping that of GDP by double-digits
  • The IMF issued a warning to Beijing to tackle corporate debt levels in SOEs, by liquidating the weakest firms and restructurings
  • More than 20 bond defaults have been confirmed this year

China’s credit markets continue to expand. In June the International Monetary Fund (IMF) issued a warning to Beijing to tackle corporate debt levels in state-owned enterprises (SOEs), by liquidating the weakest firms and restructurings. Defaults are rising from a low base. More than 20 bond defaults have been confirmed this year – an unprecedented number – as many companies, especially in industries with surplus production, struggle to meet their obligations amid China’s economic transformation.

In August the government acted to dispel the perception that it will always backstop losses for SOEs. An editorial in the People’s Daily, the official communist party mouthpiece, stated that bond defaults by Chinese SOEs should be handled through market-based mechanisms and the legal system. “Guaranteed repayment of bonds raises risks in SOE bonds and leads to higher leverage ratios and a build-up of risks,” the editorial said.

According to Investec Asset Management, by talking tough on defaults, Beijing seems to be keen to slow the rate at which corporate debt is growing. Currently credit growth is outstripping that of GDP by double-digit percentage points and the authorities are keen to slow this to come more in line to the economy as a whole. The China Banking and Regulatory Commission has also proposed to local banks and financial institutions for a coal and steel debt-to-equity programme to be established to help reduce the debt load.

"This trend may not necessarily be unwelcome, as it suggests China recognises that weaker companies should be allowed to fail. But which companies will default is hard to spot. China’s domestic credit-rating agencies have given an investment-grade rating to 99.5% of all publicly issued bonds. But again there are mixed messages. On 4 August, the National Business Daily published a piece suggesting that banks should act together and not “randomly stop giving or pulling loans.” Rather it suggested that they should either provide new loans after taking back the old ones or provide a loan extension, to fully help companies to solve their problems" the Investec team concludes.
 

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