China's Debt Surge Has Potential to Pressure Ratings, S&P Says

Updated on
  • Yuan depreciation expectations spurring onshore borrowing
  • Nation's debt as percentage of GDP was 232% at end of 2014

China is facing systemic risks and potential pressure to its ratings as record-low interest rates and a scramble to repay overseas corporate loans fuel a borrowing spree, according to Standard & Poor’s.

The yuan’s worsening outlook is spurring some Chinese companies to raise funds onshore to pay down foreign-currency debt, which could contribute to higher domestic leverage over the next one to two years, Kim Eng Tan, senior director of Asia-Pacific sovereign ratings, said in an interview in Shanghai. Also, local firms tend to borrow as much as they can during an easing cycle, he added.

Total social financing and new yuan loans both jumped to all-time highs last month, after the central bank cut interest rates six times since November 2014 and reduced lenders’ reserve-requirement ratios. The cost of servicing overseas debt climbed last year as the yuan weakened 4.5 percent and the currency is forecast to drop a further 3.1 percent in 2016. China’s debt-to-gross-domestic-product ratio climbed to 232 percent at the end of 2014, the highest since Bloomberg started compiling the data in 2004.

“The ratio continued to climb, albeit at a slower pace,” said Singapore-based Tan. “While corporate financial risks are not as high as what the leverage level suggests -- as companies tend to hold a lot of liquid assets -- the increase in the debt-to-GDP ratio still poses a systemic risk, which could potentially add pressure to ratings.”

Downgrade Risk

China’s long-term credit rating is AA-, with a stable outlook, according to S&P. That’s the fourth-highest ranking and puts the country on a par with Chile and South Korea. In a November report, the company said China could be downgraded if weak economic or financial sector trends materially increase the government’s contingent fiscal liabilities, or if policy makers try to boost growth by expanding credit to fund investment spending.

China’s budget-deficit ratio is likely to rise this year from 2.3 percent of GDP in 2015, the official Xinhua News Agency reported on Dec. 28, citing a statement issued after a national fiscal work conference. Local government bond issuance may increase to as much as 5 trillion yuan ($768 billion) this year from 3.8 trillion yuan in 2015, according to China International Capital Corp.

Companies raised a net 454.7 billion yuan by issuing bonds in January, about 2.5 times the amount a year earlier, while new yuan loans jumped to 2.51 trillion yuan. Part of the borrowing demand was because companies had to repay external debt, according to Goldman Sachs Group Inc. and Australia & New Zealand Banking Group Ltd.

“History has shown that China’s monetary policy change can be swift and unexpected,” said Tan. “Companies are wary of sudden changes, and such behavior contributes to the addition of leverage.”