China Takes a Hard Look at Corporate Borrowers

The U.S. and Europe aren’t the only places where authorities are trying to wean economies off easy money. In China, policymakers and fiscal regulators are working hand in hand to defuse a debt bomb. But they’re doing it without resorting to big interest rate hikes that might crimp growth.

China’s total debt equaled 162 percentage of gross domestic product in 2008. By 2016 it had climbed to 259 percentage, an increase of more than $ 22 trillion, in large portion because of massive corporate borrowing. And even with the current push to deleverage, it could reach 327 percentage by 2022, according to Bloomberg Economics.

Speaking at an annual assemble of economic policymakers in Beijing in December, President Xi Jinping said curbing pollution, cutting poverty, and reducing indebtednes risks are the” critical battles” over the next three years. Zhou Xiaochuan, governor of the central bank, has warned that China may experience a “Minsky Moment” — a hard landing after an extended period of debt-fueled growth.

Since Xi consolidated power at a key Communist Party meeting late last year, China has doubled down on measures to address excess in the financial system, including rules and regulations to curb off-balance-sheet giving by banks and other fiscal mediators. Last year the government began reining in some of the country’s acquisitive private conglomerates–including HNA Group, Anbang Insurance Group, and Dalian Wanda Group–to avoid the kind of debt-fueled, cross-border trophy bargains that got the Japanese in trouble back in the early 1990 s.

Guo Shuqing, China’s top banking regulator–who many think is poised to become the next head of the central bank–has vowed to take action against those who built large financial conglomerates through complex ownership structures, which often disguise true debt levels.

HNA, a no-name regional airline that grew into a sprawling conglomerate, is already uncomfortably close to the edge of the abyss. It had $190 billion of assets–more than at American Express Co.–as of June, including stakes in everything from Deutsche Bank AG to Hilton Worldwide Holdings Inc . and properties on Third Avenue and Park Avenue in New York. Under pressure from the government, HNA has gone on a accident diet. It needs to sell off assets rapidly to cover a potential shortfall of at least 15 billion yuan ($ 2.4 billion) in the first quarter, according to people familiar with the situation.

Dalian Wanda, a conglomerate that includes the world’s largest cinema operator, has bailed out of luxury hotel and resort projects from London to Australia in recent months to raise money amid rising Chinese government scrutiny of how it financed a decade-long overseas expansion. Others are expected to follow, including insurance giant Anbang, proprietor of the Waldorf Astoria.

On the heels of a commotion of dealmaking in 2016 that thrust China to No. 2 behind the U.S. on the ranking of global acquirers, Beijing laid down new rules on overseas investments, building explicit its de facto campaign against ” irrational” acquisitions in industries such as real estate, gambling, and entertainment, while blessing outlays in support of the government’s One Belt, One Road initiative. The effect was immediate: Total capital outflows fell to $408 billion in 2017, half of the total for 2016, according to Natixis SA.” We expect the capital outflows condition in 2018 to remain stable as the scrutiny measures on cross-border capital movement are certainly running ,” says Alicia Garcia-Herrero, the firm’s chief economist for Asia Pacific.

China’s banking regulator last summer ordered lenders to examine their exposure to private conglomerates, which was a way to slow borrowing by firms without raising benchmark interest rates. In China, the amount of giving, rather than official interest rates, is the best indicator of how tight or loose government monetary policy is. And the picture is pretty clear: Broad-based money supply growth slackened to 8.2 percent in December, the weakest since data became available in 1998.” They are stiffening ,” says Chetan Ahya, chief Asia economist at Morgan Stanley.” China has always relied more on actually controlling the flow of credit through direct measures .”

While official interest rates haven’t risen, the crackdown has pushed up borrowing costs for companies. The median yield on five-year bonds from top-rated Chinese corporates has jumped 1.5 percentage points since the beginning of 2017, to 5.47 percentage, the highest level since May 2014, according to ChinaBond data.” If you are a cash-rich firm, you can still pursue deals as there is a desire. But if you are a debt-fueled one, you won’t be able to pass the regulatory check ,” says Zhang Shuncheng, a Shanghai-based analyst at Fitch Ratings Ltd.

The task of China’s policymakers is constructed easier by the fact that the debt problem is restricted largely to the corporate sector, as household and government debt levels are relatively low. Also, solid growth and robust exports have given officials a window to slow the pace of credit growth with targeted measures without triggering a slowdown. Economists surveyed by Bloomberg project the economy’s expansion will slow to a still-healthy 6.5 percentage this year, from last year’s 6.9 percent.

What’s good for China as a whole may not be so good for companies that had become hooked on cheap borrowing.” The big conglomerates may think twice before they take on ever more debt ,” says Nigel Stevenson, an analyst at fiscal research firm GMT Research Ltd. in Hong Kong.” Previously they may have assumed the lenders would always support them .”

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