China has huge corporate debt. At $ 27 trillion, it has a debt-to-GDP ratio of 159%, nearly 60% higher than the global rate and nearly double that of the United States, according to a study released this month by S&P Global. Ratings.
“China’s growth has been driven largely by two contours: one is credit and the other is carbon,” says Eunice Tan, one of the report’s lead authors and head of credit research for the region. Asia-Pacific by S&P Global Ratings.
Beijing now wants to tame these two economic engines – credit and carbon – while maintaining stability and control, and while continuing to meet GDP growth targets. Carbon side, it has published a high-level policy framework outlining the way forward to achieve peak carbon emissions by 2030. On the credit front, the central bank has sought to bring debt in the real estate sector under control and protect banks from exposure to developers by difficulty.
Which industries are the most indebted?
While indebted Chinese real estate developer Evergrande has been in the limelight for all the wrong reasons lately, real estate isn’t the only heavily indebted industry in the country. Evergrande has so far managed to avoid what would have been one of the biggest defaults in history, but many other companies in the Chinese corporate landscape are in debt.
In its report, S&P Global Ratings sampled more than 25,000 companies, of which more than 5,700 were based in China. Looking at the financial data of these Chinese companies, they found that construction and engineering were the most heavily leveraged, with 91% of companies having a high level of debt. According to S&P parameters, a company is considered to have a high level of debt if its free cash flow is less than 12% of its total debt.
After construction and engineering, the second most indebted sector is transportation. Tan explained that the sector includes both transport infrastructure and transport providers. Regional government officials have a long history of funding infrastructure investments to boost GDP growth using so-called Local Government Finance Vehicles (LGFVs) which can hide debt off the books. Beijing is now tightening restrictions on LGFVs.
Tan says that the substantial levels of Chinese corporate debt, well above global levels, highlight the risk of contagion if the Evergrande collapse were to occur. “Obviously, this highlights the simmering credit strains in some Chinese companies. “
Nonetheless, a significant reduction in Chinese corporate debt levels would require a fundamental overhaul of the country’s economic model. For decades, debt growth has fueled economic growth, and the two have become so intertwined that it is difficult to reduce debt without levels holding back growth. As Beijing takes action to reduce debt, a key question remains, as the title of the S&P report asks: Can China escape the corporate debt trap?
“[T]Chinese corporate sector debt levels are well above the world average, ”the report notes. “It’s a $ 27 trillion problem that is gaining more and more attention from Beijing.”