China eases on the gas pedal to cut debt as the level of corporate borrowings dropped in 2018
- ‘Modest erosion’ in debt-to-earnings levels in 2018 expected to continue this year, S&P says
- Mining, retail among sectors that have seen the most deterioration, the rating agency says
Financial risk has increased among Chinese companies as efforts to cut corporate debt over the past few years have been put on pause as the mainland’s economy has slowed, according to S&P Global Ratings.
China’s largest companies saw a “modest erosion” in debt-to-earnings levels in 2018 and that trend is expected to continue this year, the credit rating agency said in a report after conducting a survey of 257 companies in China.
“After lowering leverage over 2015-2017, many companies had buffers to weather tougher operating conditions,” Cindy H. Huang and Chang Li said in a report dated Monday. “Nevertheless, financial risk increased across most of the 21 sectors surveyed. And most of the deterioration occurred in the lower-rated sectors, including mining and retail.”
The increase in debt levels comes after a campaign by Chinese authorities in recent years to reduce corporate borrowing levels, known as deleveraging. That has included asset sales by companies, such as Anbang Insurance Group, HNA Group and Dalian Wanda Group in recent years.
It also comes against the backdrop of a slowing economy in China and a trade war between Washington and Beijing that has weighed on global trade and investment for more than a year.
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China’s gross domestic product growth slowed to 6 per cent in the quarter, hitting the lower end of the government’s target for the year.
JPMorgan Asset Management said in a research note last week that it expects China’s GDP growth to average 4.4 per cent over the next 10 to 15 years as it becomes a richer economy on a per capita basis.
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“Growth in global trade appears to have come to a halt in recent quarters amid persistent US-China trade tensions,” JPMorgan Asset Management strategists Michael Hood and Hannah Anderson said in the note. “The countries that rode an earlier globalisation wave also benefited from improving export prices, another phenomenon that has faded. Both volume and price dynamics will make it more difficult for China to achieve rapid, trade-driven GDP growth from here.”
David Woo, foreign exchange, rates and emerging markets strategist at Bank of America Securities, said the consensus view is that growth in China will decelerate from a level of 6.1 per cent to 5.7 per cent to 5.8 per cent “on the back of persistent uncertainty from trade tension, cyclical weakness and the policy choice of balancing growth and policy constraints.”
“Scepticism on reaching a trade deal remains as no official announcement has been made yet and the important discussion on national security, technology is still missing in phase 1 talk,” Woo said in a note dated Monday. “Market participants wonder how much more deceleration needs to be seen to trigger additional fiscal and monetary stimulus as what effect that might have on asset prices.”
In its report, S&P said narrowing margins at Chinese companies are beginning to weigh on debt servicability, which deteriorated in 2018 after improving in the prior two years.
“The setbacks in credit metrics were larger for state-owned enterprises (SOEs) than private companies. In addition to the lower profitability, SOEs are less likely to derail production plans even as cash flows weaken, given the indispensable role they play in strategically important industries,” S&P said. “We think SOEs are still of vital importance in upgrading the economic structure of China, and the government is promoting various reforms to improve SOE efficiency.”
S&P said it expects corporate debt in China to continue to creep higher, reflecting not only the slowing economy, but stagnant profitability.
“In our view, an improvement can only be brought about through structural reform,” S&P said. “This includes more substantive ‘mixed-ownership’ reform of state-controlled entities, and more market-oriented exits of inefficient or unprofitable (“zombie”) companies.”
