China’s debt risks rise, experts warn of 3 outstanding problems

China’s debt risks rise, experts warn of 3 outstanding problems

Weaknesses have emerged in China’s growing debt load.

China’s national debt has grown to nearly four times GDP. Photo: AFP

China’s national debt level has grown to nearly four times GDP, while the number of corporate bonds defaulting has increased over the past 18 months, according to analysis by CNBC.

Although the most recent defaults reflect only a fraction of China’s $13 trillion domestic bond market, a few high-profile cases have confounded investors because they’ve been around for a long time. Today, there is still a perception that the Chinese government will not let state-backed companies fail.

The case of China’s Huarong Asset Management caught investors by surprise, causing a stir in the market when the company failed to disclose its profits in a timely manner and its dollar-denominated bonds. This is downhill.

Analysts say cases like Huarong signal how the state’s so-called “implicit guarantees” are changing as the Chinese government tries to improve the quality of the bond market by eliminating public companies. weaker firms and allows for some differentiation in the industry.

As China’s growth slows, officials are finding a better balance between maintaining control and injecting some market-driven momentum into the economy to sustain growth in the long run. term.

In the first half of this year, the total number of corporate bonds defaulting in China amounted to 62.59 billion yuan ($9.68 billion) – the highest level for the first half of the year since 2014, according to the report. data from Fitch Ratings. In particular, the defaults of state-owned companies accounted for more than half of the total amount, about 35.65 billion yuan.

Fitch Ratings notes that, for the full year of 2020, China’s bond defaults amounted to 146.77 billion yuan, a huge jump from 2014. In 2014, the total number of bond defaults was 146.77 billion yuan. 1.34 billion yuan and no defaults of state-owned companies.

In this regard, economists believe that investors need to pay attention to 3 important developments.

DRAWin debt tbonds in “gray area”

Firstly, bond default is in the “gray zone” (referring to the problem of not having a clear regulation) of the local government. A key milestone against the notion that there is an “implicit guarantee” in the Chinese market is the default of bonds issued by local government finance companies (LGFVs).

These companies are usually wholly owned by local governments in China, and are established to finance public infrastructure projects. Bonds issued by such companies have surged amid China’s infrastructure development as the economy improves.

“Many local government financial firms (LGFVs) are even worse than so-called companies,” said Larry Hu, chief China economist at Macquarie Financial Services Group. Zombie company in the sense that they can’t pay interest, let alone principal.

Zombie companies are understood as entities steeped in debt, living off government loans and grants. “They can only survive because of the support of the government,” Mr. Larry Hu added.

“The year 2021 is the time to break the implicit guarantee, as it is the first time in a decade that policymakers are not worried about the GDP growth target. Therefore, they accept the credit risk. more,” said Mr. Hu, asserting that it was only a matter of time before the default on bonds issued by local government financial companies.

In 2015, electrical appliance maker Baoding Tianwei became the first state-owned enterprise to default, following its first default on China’s bond market a year earlier.

Financial firm Nomura said that local government financial companies are the “main focus” of China’s tightening move; It also noted that bonds issued by Chinese financial companies have grown to a record 1.9 trillion yuan ($292.87 billion) in 2021, from 600 billion yuan in 2018.

Bank of America analysts said that a key factor affecting the performance of China’s investment bond market in the future is how the management company handles the case. Huarong Asset Management, what it calls a “huge danger”.

Huarong, China’s largest bad debt management company, has struggled with failed investments and a corruption case involving its former chairman.

After missing a plan to release 2020 business results in March, Huarong said “auditors will need more information and time to complete” the audit procedures. However, the company explained that the failure to publish results is not a default.

The Ministry of Finance is Huarong’s strongest backer. China’s economy will need to grow fast enough to ensure that the central government’s budget is not strained further.

According to Bank of America, if the Huarong case is resolved with the support of the Chinese government, it will promote the improvement of China’s wealth management sector, as well as other government-related institutions. China.

However, “if Huarong’s USD-denominated bonds defaulted in a chaotic manner, we could see a widespread sell-off in Chinese credits, especially investment credits,” Bank of China said in a statement. of America reviews.

Chinese authorities urged Huarong to divest by selling non-core assets in an effort to reform, Reuters reported earlier this month.

In the event of Huarong’s default, the cost of capital, or “return on investment” from an investor’s perspective, could increase significantly for other SOEs as “the market re-evaluates perceptions of implicit state guarantees,” said Chang Wei-Liang, a macro analyst at DBS Bank (Singapore). As risk increases, companies must commit to higher returns to attract investors.

DBS banking expert thinks that China has enough money to solve Huarong’s problems.

However, “the key question is whether the Chinese state will choose to intervene by injecting more capital, or by forcing equity holders and former creditors to incur losses in order to strengthen market rules.” Mr. Chang Wei-Liang added.

Weakness of the some local and the bank

In an effort to find potential flashpoints for China’s state-owned enterprise defaults, S&P Global Ratings analysts found small banks concentrated in the North. and the south-central part of China face declining asset quality.

“Commercial banks in cities and rural areas with above-average bad debts of the banking industry will have to write off loans worth 69 billion yuan to bring the bad debt ratio back to normal levels. industry average, with banks in the Northeast (China) being the hardest hit,” S&P Global Ratings said in a June 29 report.

This could affect the ability of small banks to support local SOEs, potentially even forcing larger banks to intervene to maintain system stability. , the S&P Global Ratings report added.

Ming Tan, credit analyst at S&P Global Ratings, said that China’s provinces have a bigger problem than those with cyclical industries.

The expert said that Chinese authorities need to strike a balance between accepting lower-quality loans with a higher level of risk and controlling problems that do not progress.

“There’s certainly a risk of mismanagement going on, but so far what we’ve seen is this is pretty well managed,” said Ming Tan.

Last week, China’s banking and insurance regulator revealed that last year, the banking industry handled a record-high 3.02 trillion yuan ($465.76 billion) in bad debt. ). Other data released last week showed China’s second quarter GDP growth of 7.9% year-on-year, lower than previous forecasts.

Some analysts have pointed to weaknesses at the local level in China. Analysis by Pinpoint Asset Management Company shows that consumption in May in the capitals of four provinces (China), including Wuhan, Guiyang, Shijiazhuang and Yinchuan.

“A financially weaker province could be related to the situation,” said Francoise Huang, senior economist at Euler Hermes Credit Insurance, a subsidiary of Allianz Financial Group. the economy is less active; (and) the weakening economic situation means there could be more corporate bond defaults”.

The female expert of Euler Hermes said that the long-term problem is to restructure the economy of these weak provinces to create conditions for more dynamic provinces to develop. “I don’t think the solution will be to (continue) to invest in less productive sectors just for the sake of keeping these sectors alive,” bFrancoise Huang commented.