In 2018, China's macro leverage ratio was 1.5 percentage points lower than that of 2017. Image: iStock

China experienced an unprecedented wave of corporate defaults in 2018. Yet investors haven’t seen anything yet as mainland growth hits a wall.

Are those US$18 billion of defaults, up from $4 billion in 2017, the mere tip of the proverbial iceberg? Odds are, yes, as US President Donald Trump’s trade war shoulder-checks China’s export engine, complicating executives’ ability to make bond payments. And that could spell trouble for global markets fearing a deepening slowdown in the second-biggest economy.

So far in 2019, companies missed nearly $2 billion of local note payments. That could be a bad omen for the $716 billion of bonds maturing over the next 10 months. The same goes for cash-flow realities. The cash-on-hand deficit relative to debt payments is now the highest in six years.

The problem with 2019 is how the clock is catching up with Beijing’s stimulus efforts. In many ways, China Minsheng Investment Group’s journey tells the story.

Less than five years ago, Shanghai-based CMIG was touted as China’s future answer to Goldman Sachs or JPMorgan Chase. Its ambitions seemed to embody China President Xi Jinping’s vision of the most populous nation spreading its wings globally. After Dong Wenbiao founded CMIG in 2014, he convinced 59 non-state operations to become shareholders and won a public endorsement from Premier Li Keqiang.

Over time, mismanagement collided with Xi’s moves to squeeze excesses out of the financial system. Efforts to curb the shadow banks, a key source of private-sector support, are catching up with aggressive debt issuers. Add in Trump’s trade war, financial chaos emanating from Brexit and Federal Reserve tightening, and you have a near-perfect financial storm.

By January 29, the pressure became too much for CMIG, which missed a bond payment. The same with Wintime Energy, China’s biggest defaulter in 2018. Wintime is a coal miner. Fitting since it, like CMIG and other companies now on the brink, is playing the role of the canary in the global economic mine.

Tax cuts

As Chinese growth slows, Xi’s government has swung into stimulus mode. Tax cuts, new business loans, central bank liquidity, giant infrastructure projects, you name it. Yet the sharp drop in exports and the specter of more Trump tariffs are sending intensifying headwinds China’s way.

These forces are bumping into a deleveraging campaign that Xi set in motion in 2016. That makes it harder for companies facing repayment troubles to raise new funds. The lagging effects of that crackdown are counteracting efforts by the People’s Bank of China to ease the liquidity crunch.

“Given the reduced risk appetite and huge maturing volume, the outlook is poor,” Nathan Chow, an analysts Nathan Chow and Eugene Leow of DBS Bank, wrote in a recent report.

There are two risks worth considering – one in the short term, one of the long-term variety.

The immediate concern is how a bull market in Chinese defaults affect world markets. As the Brexit mess hogs headlines, investors may be underappreciating credit risks in eurozone economies. Last month, the European Central Bank warned of possible debt dislocations hiding in plain sight.

Slowing growth

Hints of slowing US growth are mentioned as Washington’s debt load hits the $22 trillion mark. Japan is skirting recession anew, while the downshift in Chinese growth is imperiling exports from Seoul to Sydney. Heightened turmoil in China would slam markets around the globe. That was the case in 2015 when mainland stocks plunged. It will be doubly true if a domino effect of defaults crashes into credit markets.

The longer-term worry is China’s risk profile. In his six-plus years at the helm, Xi showed little appetite for slower gross domestic product growth. Sure, China’s 6.6% growth in 2018 was well below the 7.9% pace of 2012. But any serious effort to recalibrate engines from exports to domestic innovation, and from smokestacks to services, necessitates slower GDP.

The longer GDP stays above, say, 5%, the less Team Xi is doing below the surface. Re-engineering China Inc. and beating its debt addiction will be deeply disruptive. Xi too often opts for stimulus over reform. China’s debt troubles are still growing. It means that when reckoning arrives for the world’s second-largest economy, the fallout will be even bigger and more spectacular.

Xi must raise his multitasking game. As he invests trillions of dollars in “Made in China 2025” and a Greater Bay Area rival to Silicon Valley, he must simultaneously strengthen the economy’s foundations. That includes a credit-risk system that limits the ability of companies to overborrow.

That is easier said than done at a moment when defaults and economic gloom dominate headlines. Yet this is China’s lot for the year ahead. The only question is how much of the fallout Beijing shares with world markets.

Leave a comment

Your email address will not be published. Required fields are marked *