Record Spread Blowout Sparks Mini-Crisis Warning: China CreditJustina Lee
Chinese companies’ borrowing costs are climbing at a record pace relative to the government’s, increasing the risk of defaults and prompting state newspapers to warn of a limited debt crisis.
The extra yield investors demand to hold three-year AAA corporate bonds instead of government notes surged 35 basis points last week to 182 basis points, the biggest increase since data became available in September 2007, Chinabond indexes show. That exceeds the similar spread in India of 120 basis points. The benchmark seven-day repurchase rate has averaged 4.47 percent in November, the highest since a record cash crunch in June and up from 3.21 percent a year earlier.
“Existing interest-rate levels and tighter credit conditions will pose downward pressure on growth,” said Kewei Yang, head of Asia-Pacific interest-rate strategy at Morgan Stanley in Hong Kong. “Any potential defaults or bankruptcies in 2014 will trigger the market to reprice credit risk.”
A People’s Bank of China pledge to prevent excessive leveraging has contributed to the surge in borrowing costs, prompting state-run newspapers from China Securities Journal to Economic Information Daily to call for easier monetary policy to prevent a slump in economic growth. The debt of listed companies excluding financial firms has doubled since 2009 to some $2 trillion. Local governments may owe 20 trillion yuan ($3.3 trillion), Liu Yuhui, a researcher at the Chinese Academy of Social Sciences, said in September.
Borrowing ratios at some Chinese corporations are already relatively high, and rising interest rates may cause a “partial debt crisis to explode,” the China Securities Journal said in a front-page commentary yesterday. The central bank should take a “mild” approach to deleveraging as the economy is still delicately balanced, said the Economic Information Daily.
The 10-year government bond yield rose to 4.72 percent on Nov. 20, the highest in at least six years, amid speculation interest-rate reforms will raise funding costs. The rate fell one basis point to 4.61 percent yesterday.
“If the deleveraging process proceeds at a relatively fast pace and government bond yields remain at high levels, the high ’risk-free rate’ will pass through to corporate bonds and other credit assets, and eventually weigh on economic growth,” Morgan Stanley’s Yang said in a Nov. 25 phone interview.
Issuers have postponed or scrapped at least 73.5 billion yuan of notes this month, more than double the 29.8 billion yuan pulled in October, according to filings on the websites of Chinamoney, Chinabond and Shanghai Clearing House. China Development Bank and Agricultural Development Bank of China are among borrowers that delayed or downsized bond offerings this month.
“With such high funding costs, there’s no impetus for companies to expand,” said Qiu Xinhong, a bond fund manager at Golden Eagle Asset Management Co. in Guangzhou, which oversees about 10 billion yuan in assets. “Losses at some companies may cause the economy to slow.”
Tighter cash supply could damage early signs of a recovery in the world’s second-largest economy. A preliminary gauge of Chinese manufacturing declined for the first time in four months in November, an HSBC Holdings Plc and Markit Economics index showed Nov. 21. Growth will slow in the three months through December as well as in the next three quarters, according to Bloomberg surveys of economists.
Premier Li Keqiang has set a 7.5 percent expansion target for this year, which would be threatened if there is a repeat of the cash crunch in June that was engineered to punish excessive lending. The PBOC added funds to the financial system recently, putting in 32 billion yuan yesterday after pumping in a net 59 billion yuan last week. The yuan, which has risen 2.3 percent this year, was little changed at 6.0923 per dollar as of 11:44 a.m. in Shanghai today. The nation should continue to increase the flexibility of the yuan and ensure it is basically stable, People’s Bank of China Deputy Governor Yi Gang was cited as saying in a Xinhua News Agency interview published yesterday.
“Although we don’t view the current situation as dangerous, since we do believe that the PBOC is willing to add liquidity at the margins in the event that money markets seize up entirely, the sharp general rise in interest rates is not without consequences,” said Michael Shaoul, New York-based chief executive officer of Marketfield Asset Management LLC, which oversees some $18 billion. “Higher rates mean lower profits for borrowers. More seriously, the higher yields may reflect a genuine shortage of capital.”
The nation’s total debt, led by state-owned enterprises and local governments, may exceed 200 percent of gross domestic product, according to a Barclays Plc report yesterday. Implicit government guarantees and soft budget constraints have encouraged excessive borrowing and increased the potential for defaults, the analysts wrote.
These guarantees are now looking increasingly uncertain with China’s Communist Party saying at the Nov. 9-12 plenum that it would encourage private investment in state-owned enterprises, which have enjoyed sheltered monopolies for years, and allow competition. The leadership pledged also to give markets a “decisive” role in the allocation of resources.
Premier Li’s predecessor, Wen Jiabao, turned China into the world’s biggest maker of solar panels through spending including $47.5 billion of credit lines that crippled the industry with overcapacity. Solar-wafer maker LDK Solar Co. said yesterday it obtained a two-week reprieve from having to pay interest that was due Aug. 28, the third extension for payments owed on the company’s 2014 securities.
“Once defaults happen, even if it is a small or mid-sized company at the beginning, it will significantly affect the pricing of credit-risk premium” said Yang. “It is reasonable to expect rising risk in 2014 for the corporate bond market.”