Chinese Debt; The Looming Crisis

2.6 trillion yuan, or around $0.5 trillion of Chinese non-financial corporate debt is expected to come due during 2014. This figure includes principal repayments and interest and is the largest figure on record for Chinese companies. Last year gear ratios among non-financial Chinese companies reached 93%, while the average across Asia remained below 70% and has done for the past decade.

But with so much debt coming up for repayment, Chinese companies are facing an increasingly hostile lending environment. Back during December Chinese ten-year AAA rated corporate bond yields hit 6.2%, while the average rate for similar-rated notes globally touched 2.68%.

Still, there have been no corporate bond defaults in China’s publicly traded debt market since the central bank started regulating back in 1997. However, with levels of gearing hitting a record, a record amount of debt coming up for maturity and bond yields soaring, a perfect storm could be brewing.

Cracks already appear to be showing in the market as the Industrial & Commercial Bank of China more than tripled its bad loan provisions during the first six months of last year, from 7.7 billion yuan, to 22.1 billion yuan. China’s courts have also seen a surge in bankruptcies.

Unfortunately, if things start to go wrong the whole country could be engulfed in a financial crisis very quickly. The shadow banking industry within China is huge and the use of wealth management products, of WMP, which use a pool of instruments such as securitized debt to achieve an above average return, has surged recently. The yields on these instruments has hit an all-time high of 5% to 8% recently. Defaults by corporate bodies, or local government agencies could hit this WMP market hard and it would not be long before the market capitulated.

Luckily, the Chinese credit market is somewhat contained, so a credit crisis would not be as catastrophic as ’08 but with around $2.8 trillion in government and many trillions in corporate debt outstanding within China, repercussions of a debt crisis would be felt around the world.

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