China debt market feeling the heat in June with two big defaults and a government order to reduce risk
- Energy and mining conglomerate Qinghai Provincial Investment Group confirmed in a statement on Monday that it had filed for bankruptcy
- Last week, Sichuan Trust said it would be unable to repay investors and a vice-governor of Yunnan province ordered all state firms to slash debt size and to restructure all high-interest debts
A bankruptcy by a heavily indebted state enterprise backed by a provincial government, a large trust investment firm being unable to pay its investors and an order to all state firms in a southwestern province to restructure their debts are all recent incidents that have further highlighted the growing stress in China’s debt market.
Energy and mining conglomerate Qinghai Provincial Investment Group, which is ultimately owned by the state-owned asset watchdog for Qinghai province, had already defaulted on its offshore US dollar bonds in February before confirming in a statement on Monday that it had filed for bankruptcy.
Chinese magazine Caixin called the bankruptcy as a sign of “the collapse of blind faith in state-owned enterprise [for bond investors]”.
Last week, Sichuan Trust said it would be unable to repay investors, partly because the company had lost control over where the raised funds were invested. The final loss could reach billions of yuan, raising fresh concerns about the safety of institutions within China’s shadow banking industry that link retail investors with investment projects.
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At the same time, a vice-governor of Yunnan province last week ordered all state firms in the province to slash debt size and to restructure all debts with an annual interest rate above 7 per cent through “all possible means”, according to a circular issued by the Yunnan provincial state assets watchdog.
The extraordinary move by a local government placing a ceiling on borrowing cost is seen as a desperate move by one of the most indebted provinces to avoid defaults.
Four major financing vehicles backed by the provincial government, including Yunnan Urban Construction Investment Group, are currently in danger of bond defaults and were specifically mentioned in the circular.
The three events took place at a time when debt levels are rising quickly amid the fallout from the coronavirus outbreak, reflecting the growing risk if Beijing fails to achieve a high enough nominal growth rate to help with repayments after China’s economy shrank 5.8 per cent in the first quarter of 2020.
The authority may not want to see defaults in a special year like 2020
“The authority may not want to see defaults in a special year like 2020,” said Ding Shuang, chief Greater China economist at Standard Chartered Bank.
“State-owned enterprises and financing vehicles remain important to build infrastructure projects vital for economic stabilisation purposes. They are still favoured by banks.”
Yunnan’s economy grew 8.1 per cent last year, the second highest among the 31 mainland Chinese provincial-level economies, but it remains one of the most indebted having reported 810.8 billion yuan (US$114.5 billion) of confirmed debt at the end of last year, an increase of 96.8 billion yuan.
“Each province has respective solutions, including assets liquidation or land sales, since the central government ordered implicit debt disposal from 2018. The pace, however, has been greatly interrupted by the country’s tax cut plans and the pandemic,” said Amanda Du, a Moody’s vice-president based in Shanghai.
“The presence of the government may help ease debt risk and boost investors’ sentiment in local government financing vehicles. However, local governments’ capacity to provide support vary significantly across cities and provinces in China and investors should not take support on individual local government financing vehicles for granted ,” Du warned.
In 2015, the central government swapped all local government debt with bond sales, trying to make them transparent and also lower financial cost amid the interest rate down-cycle, however, it opted against a similar swap of implicit debt in response to the impact of the coronavirus.
Although refraining itself from a Western-alike stimulus to help its coronavirus-hit economy, the People’s Bank of China has provided funding, including 1.8 trillion yuan (US$254 billion) of relending quota and three cuts of the required reserve ratio.
Bank credit also reached 10.3 trillion yuan (US$1.5 trillion) in the first five months of the year, with central bank governor Yi Gang saying last week that it could reach a record high of 20 trillion yuan for the whole of 2020.
First-quarter onshore local government financing vehicle bond issuance also totalled 1.06 trillion yuan (US$150 billion), a record high, and up 23 per cent from a year earlier.
Moody’s believes supportive domestic credit easing measures to counter the negative impact from the coronavirus pandemic could continue to facilitate bond issuance for the remainder of this year.
China's total debt as a percentage of gross domestic product (GDP) has also increased sharply in the first quarter of 2020, according to a research note by Natixis published last week. According to the French bank's estimate, China's government, corporate and household debts rose as much as 11 percentage points to 258 per cent of GDP at the start of the year.
