China Inc. Resists Li Reform Push as Debt Swells Most Since 2012

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  • Debt for non-financial companies listed in Shanghai rose 18%
  • Debt-to-equity leverage rose to six-year high of 123 percent

For all Premier Li Keqiang’s rhetoric about unrelenting economic reform, companies listed in Shanghai are building up debt at the fastest pace in three years as it gets harder to finance growth from earnings.

Total debt at 1,003 Shanghai-traded non-financial firms increased 18 percent in the last 12 months, the fastest pace in three years, to a record 868.3 billion yuan ($136 billion), the latest Bloomberg-compiled filings show. The debt-to-common equity ratio, adjusted for market value, has risen to 123.1 percent from 121.5 percent a year ago and 88.7 percent back in 2010.

China’s growing debt pile is at odds with Premier Li’s vow to rebalance the world’s second-largest economy and reform bloated state-owned enterprises. Banks are straining under the most nonperforming loans since 2008 while attempts to make the equity market an avenue for deleveraging ended in a market collapse and a freeze in initial public offerings in July.

“The long-awaited deleveraging of China’s corporate sector hasn’t started yet,” said Xia Le, the chief economist for Asia at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. “Firms are still piling up debt in support of their capital spending.”

About 16 percent of companies listed on the Shanghai stock exchange generated losses in the last 12 months, more than double the number a year ago, Bloomberg-compiled data show. Government, corporate and household obligations ballooned to $28.2 trillion, or 282 percent of China’s gross domestic product as of mid-2014, according to McKinsey & Co., and in April, a state-owned enterprise became the first ever to miss an onshore payment obligation.

Unadjusted, the average debt-to-common equity ratio looks even worse, at a 205.7 percent, the highest in at least a decade. Eleven companies have a ratio exceeding 1,000 percent. Onshore bond sales from non-financial companies total 3.1 trillion yuan this year, up from 2.4 trillion yuan the same period of 2014, Bloomberg-complied data show. The Shanghai Composite Index has now declined 39.7 percent since its June 12 peak after losing 2.7 percent today, the most in three weeks.

Weaker demand for Chinese goods could add to the stress facing those companies that rely on selling their wares to the rest of the world. Exports declined for a second consecutive month in August and although the People’s Bank of China devalued the yuan last month, a move some economists said was to tackle weakening exports, any impact is yet to show.

“Policy makers intend to reduce leverage in the economy, but they’re also trying to make it a smooth process,” Zhu Qibing, a Beijing-based analyst at China Minzu Securities Co., said. “That’s why the government has focused on developing the bond market as a financing venue for Chinese companies.”

Borrowing expenses for smaller, private-sector companies are also still elevated, with data from the Wenzhou Private Finance Index putting funding costs for small to medium-sized enterprises at 17.5 percent on a national level versus a one-year benchmark lending rate of 4.6 percent.

“The rising debt-to-equity ratio of listed companies shows that the wealth creation in China heavily relies on credit expansion,” said Zhao Yang, the chief China economist at Nomura Holdings Inc. in Hong Kong. Companies already have a lot of debt and taking on any more may prove dangerous, he said.

The cost of insuring Chinese government debt against nonpayment using credit-default swaps rose to 122.4 basis points Aug. 24, the most in two years, CMA data show. It’s since fallen to 119.5, up 34 basis points this year.

In another indicator of weakness among China’s corporates, the official factory gauge fell to the lowest reading in three years last month, and fixed-asset investment in August rose at the slowest pace in 15 years. Premier Li sought to soothe concerns over the slowdown, saying at a World Economic Forum meeting in Dalian on Sept. 9 that China can maintain mid- to high-speed growth even under downward pressure. Officials earlier this month revised 2014 expansion to 7.3 percent from a previously reported 7.4 percent.

“The balance sheets of Chinese corporations are overstretched,” Paul Gruenwald, Standard & Poor’s Asia Pacific chief economist in Hong Kong, said. “You can’t pile on more debt and double up. It’s just not the way out any more when the economy is slowing.”