The Chinese government has introduced various deleveraging measures to reduce corporate leverage, one of its key policy targets for 2016. This includes debt-to-equity swaps, corporate tax cuts, business restructuring, tackling overcapacity, and targeting the closure of financially unviable companies.
Borrowing costs have climbed as the government has raised short-term money-market rates and tightened regulations concerning the use of debt as collateral for security purchases. After rapid growth in 2015, the Chinese bond market is now facing increasing pressure given regulatory and liquidity tightening along with surging US treasury yields.
The yield of China’s CNY-denominated sovereign bond due August 2026 has risen to 3.245% from below 3% in November, while the yield of the Chinabond corporate AAA-rated (onshore) 5-year bond index has jumped to 4.278% from 3.602% at the end of November.
Recent data showing healthy industrial output and retail sales points to economic stabilisation, which could give the government more room to push for corporate deleveraging. Higher financing costs due to further monetary tightening could raise refinancing risk and consequently default risk, as companies face CNY 4.5trn of maturities due in 2017.
Companies have cancelled or postponed at least CNY 61.4bn of bond sales so far this month, compared to CNY 29.7bn in November. Companies are likely to turn to the offshore bond and loan market for funding, given increasing onshore rates and demand from Chinese investors looking to diversify from the weakening CNY, although capital controls could restrict flows into the offshore market. Despite deleveraging efforts, the total debt at listed non-financial Chinese corporates rose by 13% in the 12 months up to 30 September.
Higher borrowing costs are likely to make it more challenging for lower-rated issuers to issue bonds, while the weakening of the CNY against the USD makes it more expensive for companies to raise offshore funding.
The central bank’s liquidity tightening measures should help bring down leverage in the system. However, weaker issuers especially those who are unable to access offshore funding could face trouble refinancing their debt in the near term.
Magdalene Teo is fixed income research Asia at Julius Baer