China’s deleveraging campaign takes a toll on the private sector, especially the battered property market
- Nicholas Spiro says an upswing in the Chinese equities market can’t disguise the beating its private firms have taken due to government efforts to rein in debt
- Furthermore, these worrying signs appear unlikely to ease as long as central banks dial back their stimulus measures
China’s battered equity market has not done too badly since hitting a four-year low in mid-October. The Shenzen Composite Index, which is dominated by private enterprises, is up nearly 6.5 per cent since October 18 – compared with a 0.5 per cent rise for the benchmark S&P 500 index – partly because of hopes that recent measures to support private firms are a prelude to more forceful action to shore up China’s economy and capital markets.
New initiatives to help the private sector, which include steps to facilitate bond sales and instructions to large banks to boost their lending to private companies, have contributed to lower volatility in Chinese stocks. According to data from Bloomberg, average intraday swings last week were the lowest this quarter. The yuan has also been more stable of late, with data published last Wednesday revealing that Beijing spent US$32 billion of its foreign reserves last month to defend the currency.
Yet, just a cursory glance at China’s deeply indebted corporate sector shows the severity of the funding squeeze faced by private firms, which have borne the brunt of the government’s two-year-old deleveraging campaign.
While Chinese government bonds have performed well this year, benefiting from measures to ease monetary policy and new rules to attract foreign investment, the corporate debt market has taken a beating.
New data from Bloomberg published last Thursday shows that 15 Chinese dollar-denominated bonds included in a Bloomberg Barclays index of emerging market corporate debt have spreads in excess of 1,000 basis points (the level at which debt is typically considered distressed), a higher number than all the other developing economies included in the gauge combined.
Separate data based on JPMorgan’s benchmark Corporate Emerging Markets Bond Index is even more revealing.
In the past month, China, which has a 25 per cent weighting in the index (twice as large as Brazil, which has the second-biggest), has suffered the sharpest increase in the spreads on its high-yield, or “junk”, bonds among the main emerging markets included in the gauge. The risk premium on Chinese high-yield bonds has risen a further 118 basis points, compared with declines for Turkish and Argentinian junk bonds of 63 and 12 basis points respectively. Since the start of this year, Chinese high-yield spreads have widened 286 basis points, on a par with the rise in Argentina and Turkey, whose economies are incomparably weaker than China’s and are the worst performing countries in the index.
Many Chinese high-yield issuers, moreover, are in the property sector, the area of the economy where the government has so far shown no leniency in its battle against excessive debt. At least four real-estate-related companies have defaulted on their bonds this year, according to Bloomberg, including Wuzhou International Holdings, a developer based in Wuxi, which in June failed to repay bonds in both the mainland and offshore markets.
In a sign of the severity of the funding strains faced by Chinese property companies, junk-rated Evergrande Group, the country’s second-largest developer by sales, sold a five-year dollar-denominated bond on October 31 at a prohibitive yield of 13.75 per cent, the third-highest coupon for an Asian high-yield issuer this year, Bloomberg’s data showed.
The liquidity crunch in China’s high-yield debt market has contributed significantly to this year’s sharp increase in the yields on Asian junk bonds, which currently stand at a six-year high. With Asian corporate bonds – both investment grade and junk – accounting for 46 per cent of JPMorgan’s benchmark index, the dramatic widening in Chinese high-yield spreads has been the key factor behind this year’s 111-basis-point rise in the spreads on emerging market junk bonds, with a third of the increase occurring in the past three months, data from JPMorgan shows.
Tighter funding conditions for less creditworthy emerging market companies are also attributable to the withdrawal of monetary stimulus by the world’s leading central banks.
In a worrying development for emerging market investors, last Thursday’s policy statement from the Federal Reserve not only confirmed that the US central bank is on track to raise interest rates four more times by the end of next year, it did not even include a reference to last month’s steep declines in global equities. As I mentioned in my previous column, investors are not just having to contend with relatively tame stimulus measures in China, they are also faced with a hawkish Fed that is loathe to intervene to prop up markets.
In order for sentiment to improve, one of these financial headwinds will have to ease. With any de-escalation in the US-China trade conflict making either prospect less likely, emerging market corporate debt investors should be careful what they wish for.
Nicholas Spiro is a partner at Lauressa Advisory