Chinese borrowers are taking on record amounts of debt to repay interest on their existing obligations, raising the risk of defaults and adding pressure on policy makers to keep financing costs low.
A street scene along Shanghai's Bund: Chinese borrowers are taking on record amounts of debt to pay interest on their existing debt, prompting the rise of zombie companies. Photo: Tamara Voninski
The amount of loans, bonds and shadow finance arranged to cover interest payments will probably rise 5 per cent this year to a record 7.6 trillion yuan ($1.65 trillion), according to Beijing-based Hua Chuang Securities, whose lead fixed-income analyst was top-ranked by China's New Fortune magazine in 2012 and 2013. Dubbed "Ponzi finance" by Hyman Minsky, the use of borrowed funds to repay interest was seen by the late US economist as an unsustainable form of credit growth that could precipitate financial crises.
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Chinese companies are struggling to generate the cash flow needed to service their obligations as economic growth slows to the weakest pace in 25 years and corporate profits shrink. While the debt burden has been eased by six central bank interest-rate cuts in 12 months and a tumble in corporate borrowing costs to five-year lows, the number of defaults in China's onshore corporate bond market has increased to six this year from just one in 2014.
"Some Chinese firms have entered the Ponzi stage because return on investment has come down very fast," said Shi Lei, the Beijing-based head of fixed-income research at Ping An Securities, a unit of the nation's second biggest insurance company. "As a result, leverage will be rising and zombie companies increasing."
Latest failure
China Shanshui Cement Group became the latest company to default on yuan-denominated domestic notes last week as overcapacity in the industry hurt profits and a shareholder dispute stymied financing. State-owned steelmaker Sinosteel, which pushed back an interest payment on a bond last month, postponed it again this week.
Metrics of corporate health in Asia's largest economy have deteriorated as growth slowed. The number of Shanghai and Shenzhen-listed companies that have less cash than short-term debt, net losses and contracting revenue has increased to 200 as of June from 115 in the year-earlier period, according to data compiled by Bloomberg.
Borrowings climb
Total debt at listed companies has climbed to 141 per cent of common equity, based on a market-capitalisation weighted average, the highest level in three years.
While the total amount of debt issued to pay interest is projected by Hua Chuang Securities to increase, it's taking up a smaller portion of overall new credit. The firm predicts such borrowing will account for 45 per cent of new total social financing -- which includes bank loans, shadow banking credit and corporate bonds -- down from 50 per cent last year.
Plunging borrowing costs have made it less expensive for Chinese companies to gain access to fresh cash. The rate on five-year corporate debt with AAA ratings dropped to a five-year low of 3.69 per cent on October 29 and was last at 3.95 per cent.
At the same time, policy makers are taking steps to insure credit keeps flowing to borrowers in need. Chinese banks shouldn't cut or withdraw lending to companies in "temporary" difficulties, Premier Li Keqiang said last month, adding that the government will take steps to prevent systemic risks. The People's Bank of China has cut its benchmark one-year lending rate to 4.35 per cent from 6 per cent a year ago, helping to fuel 6.6 per cent growth in outstanding corporate bonds this year to 19.2 trillion yuan as of October.
Defaults forecast
"The lower funding rates have lessened the interest burden on Chinese companies," said Xia Le, a Hong Kong-based economist at Banco Bilbao Vizcaya Argentaria.
Defaults will probably keep rising as profits fail to keep up with interest expenses at some Chinese borrowers, according to Zhou Hao, a senior economist at Commerzbank in Singapore. Earnings at Chinese industrial firms shrank for a fourth straight month in September, while producer prices fell for the 44th consecutive month in October. China's economic growth will probably slow to 6.9 per cent this year, the weakest pace since 1990, from 7.3 per cent in 2014, according to economist estimates.
"We will see more defaults and rising bad loans in the financial system," Zhou said.
Bloomberg