When China’s President Xi Jinping launched a supply-side structural reform plan in 2015, financial deleveraging was one of its key goals. The deleveraging campaign was meant to curb risks in the country’s overheating financial markets through crack downs on shadow financing and tightening asset management rules.
But three years down the line, Chinese companies are being handed a reality check.
After years of bingeing on debt, many firms are now struggling to raise new funds to repay old debts after the deleveraging drive has staunched liquidity and led to a slew of corporate bond defaults.
By the end of June, the current year was already on track to set a new record after companies failed to honor 33.3 billion yuan ($4.9 billion) in bond repayments, above the previous high of 30 billion yuan set in 2016 for the entire year.
But that was before the latest mega-default struck: Wintime Energy, a coal miner, has sent shockwaves through the bond industry after welching on a massive 72.2 billion yuan (10.8 billion) of securities after failing to pay a local bond. The miner has seen its total debt load quadruple in less than five years after a drop in borrowing costs encouraged it to go on an acquisition spree. Related: Gold Selloff Continues As Dollar Climbs Higher
So far, 10 private firms and 25 public ones have failed to honor their bond obligations this year--another record by the country. Local credit-rating agencies such as Dagong Global Ratings have been dishing out downgrades at an unprecedented rate.
Systemic Debt Risk
But that could merely be a precursor of things to come. China could be poised to sink even deeper into debt tailspin because the problem is highly systemic, with debt at record levels right from the government to private firms.
Wintime’s recent borrowing history epitomizes an industrywide corporate shift to direct financing that took place earlier in the decade. China’s domestic bond market quickly ballooned to around $12 trillion, the third largest in the world, as internal regulators encouraged direct financing instead of bank lending.
Consequently, the heavy dependence on the local bond market led to borrowing costs skyrocketing. Borrowing costs for one-year bonds now average seven percent compared to 4.5 percent two years ago.
Despite this, companies are still rushing to the bond market to raise more money to repay debts. Private firms in the country raised 275.4 billion yuan from bond sales during the first five months of the year, with 260 billion yuan deployed to repay debts, leaving a miniscule net financing figure.
And that could become a vicious cycle.
Debt-to-equity ratio for the Chinese corporate sector currently hovers around 160 percent, much higher than 110 percent for the S&P 500.
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Of that massive debt load, state-owned enterprises take the lion’s share at 70 percent. And it’s becoming increasingly difficult for the Beijing government to bail them out because it’s drowning in a mountain of debt itself.
Last year, the IMF pegged China’s debt load at 230 percent of GDP and warned that it could breach the 300 percent mark by 2022. The official figure by the National Development and Reform Commission puts it higher at 260 percent of GDP, while Mercator Institute of China Studies paints an ugly picture of swelling liabilities and mounting insolvencies.
Beijing’s move to deleverage was meant to uncoil that tightly wound spring and reduce market risks. But it appears as if the exercise is generating massive shocks in downstream markets thus calling for more caution.
By Alex Kimani for Safehaven.com
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