MNI Analysis: China Corporate Debt At Risk Of Fatal Spiral

     BEIJING (MNI) - Chinese non-financial corporate debt risks are likely to

rise as high leverage, industrial overcapacity and low investment efficiency

continue to negatively impact companies' profitability and debt repayment

capacity, while at the same time making them more vulnerable to real and

financial shocks, according to economists and analysts.

     The ratio of corporate debt to GDP in China is estimated to be as high as

155%, according to a recent report by the Asean+3 Macroeconomic Research Office

(AMRO), a regional macroeconomic surveillance unit of the Chiang Mai Initiative

Multilateralization (CMIM), warning that the ratio could rise to 200 percent by

2030 if the Chinese government does not carry out effective and comprehensive

structural reforms. The CMIM is a currency swap agreement among the finance

ministries and central banks of the ASEAN grouping plus China, Japan and South

Korea. 

     "The overall solvency conditions have recently improved, but debt growth

still exceeds value-added growth, especially in sectors prioritized under the

investment-led growth strategy including utilities, transport, real estate and

construction," Chaipat Poonpatpibul, senior economist with AMRO, said at a forum

on rising corporate debt in China sponsored by Tsinghua University on Monday.

     Corporate debt risk is believed to be one of the China's biggest "gray

Rhinos" -- large and neglected threats to the economy -- even as the country's

GDP growth is in line with the government's year-end target, and its main

economic indicators, including producer price inflation and consumer price

inflation, have shown positive momentum so far this year. 

     The underdevelopment of equity financing facilities compared with debt

financing, the presence of implicit guarantees to state-owned enterprises

(SOEs), and the investment-dominant stimulus structure put in place by the

Chinese government after the global financial crisis have been the main

contributors to the high corporate debt levels, according to AMRO.

     But more complicated country-specific factors are also involved. Bai

Chong-en, economics professor at Tsinghua University, noted at the forum that

"the close link between companies and government, particularly local-government

financing vehicles (LGFVs), worsens potential risks while the independence of

financial institutions still needs to be improved," he said. "Another problem is

whether local governments have enough assets to repay corporate debts they have

guaranteed when risks break out."

     "In addition, the Chinese government uses various administrative methods to

postpone the outbreak of debt risks, but it does not solve problems," Bai

stressed.

     One problem is that high corporate debts have not translated into higher

values in  certain sectors. According to AMRO, as of the end of 2016, the

debt-to-GDP ratios in the sectors of real estate, transportation and

construction were 15%, 12% and 12% respectively, while their contributions to

GDP were only 8%, 6% and 8%.

     Wang Jun, director of the CEIBS-World Bank China Center for Inclusive

Finance, told MNI, "The core of debt problem in China is the low investment

efficiency, which has been shown by the higher and higher incremental capital

output ratio," or ICOR.

     Wang said that every CNY1 of GDP output needs about CNY6 in capital

investment at present, compared with only CNY1 in investment that was needed in

the 1990s. "The high debt ratio and ICOR are unsustainable," he said.

     "The problem is that China lacks an efficient corporate bankruptcy

mechanism, so it is easy for companies to raise debt without considering their

repayment capacity, particularly the state-owned companies," Wang said.

     According to AMRO, the SOE debt-to-output ratio is much higher than that of

non-SOEs, and it is projected to grow quickly in the medium term as the ability

of SOEs to generate output from debt financing has become much lower. Zhang

Wenkui, a senior official with the State Council's Development Research Center,

said in March that SOEs are responsible for about 50% of corporate sector debt,

while their output contributes just 21% to 22% of the country's GDP.

     "The government should reduce its intervention in corporate operations and

further deepen institutional reforms, which is a substantial way it could solve

the SOEs' debt problems," Bai Chong-en told MNI in an interview after the forum.

     President Xi Jinping told senior officials at the National Financial Work

Conference in July that the government's "priority of priorities" was to curb

SOE leverage and get rid of zombie companies in coming years.

     However, regulatory tightening during the process of deleveraging will

bring a certain amount of pain to those SOEs, particularly as rising interest

rates make it more expensive for companies to refinance their debts.

     According to AMRO, the proportion of listed firms' liabilities that are of

short-term durations (less than 12 months) is more than 70%, which is

significantly higher than the global average. Meanwhile, debt risks will have a

significant impact on the financial sector, particularly smaller banks, since

they have been more aggressive in their lending practices, not only in issuing

normal loans but also in using shadow banking methods to funnel money to

companies.

     Poonpatpibul suggested that the Chinese government should make further

efforts to encourage corporates to use equity financing to raise funds, and

reduce their reliance on debt financing. "Moreover, improvements to corporate

and financial sector data are crucial for more comprehensive and effective risk

assessment and monitoring," he said.

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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