Rise in offshore corporate debt causes concern

Chinese companies' foreign debt is rising at the fastest pace since the Asian financial crisis in 1997, sparking worries of a credit crisis

There's been heated debate in financial circles about the fast growth of overseas debt among Chinese companies. Some analysts suggest that the rising external debt is "a sign of desperation". They've also warned of a possible impact on global markets.

If interest rates on dollar-denominated debt rise, these experts said, Chinese borrowers could find themselves in a financial trap, and the country could be "maxed out" in the credit markets.

Other analysts don't see a looming problem.

But the reality is that China's offshore debt has been increasing at the highest rate since the Asian financial crisis in the late 1990s.

After watching wrenching financial, currency and economic crises in neighboring countries, China clamped down on corporate borrowing abroad.

"China's external borrowing is expected to continue to expand in 2014 and 2015, although at a slower pace than in 2012 and 2013," said Stephen Green, chief economist in China at Standard Chartered Bank.

Green forecast $200 billion will be added to cross-border bank loans to China this year. Chinese companies are also set to issue about $80 billion more in tradable bonds in 2014.

The nation's external debt ratio will rise to 11.5 to 12 percent of GDP from 10 percent at present, he said.

"Offshore banks' appetite for further exposure to China's banks appears to be ebbing since many have now reached the relevant credit limits. But they are still able to sell China assets, particularly China bank assets, to others, which facilitates growth in total lending," he said.

According to the State Administration of Foreign Exchange, China's official foreign debt totaled $823 billion as of Sept 30, 2013, which was equivalent to 9 percent of GDP - a relatively small proportion in international terms.

But there have also been increases in trade credit as well as borrowing by banks in China in recent years.

Analysts said there have been several indications that the Chinese government will adopt a bolder stance on foreign debt as it strives to improve financial efficiency and help the real economy during the growth pattern transformation. Among these signs:

The National Development and Reform Commission, China's top economic planner, said in a statement on Jan 27 that the nation will "moderately expand" foreign banks' middle- and long-term overseas debt and aim to improve offshore credit management as it opens the capital account.

The NDRC said its policies are intended to encourage Chinese enterprises' efforts to go abroad and borrow in dollars.

In December, the People's Bank of China, the country's central bank, released 30 guidelines on promoting the financial development of the China (Shanghai) Pilot Free Trade Zone. The PBOC said that enterprises from the FTZ can borrow abroad.

During the Party's Third Plenum in November, top policymakers called for an "appropriate" expansion of external borrowing.

Rising interest rates for bank loans in China and tight liquidity have pushed companies to seek cheaper financing instruments in overseas capital markets.

Analysts said the slowdown in domestic credit growth seen in the second half of 2013 could persist. They said seasonal factors, such as the Lunar New Year, may have caused the 17.4 percent rise in total social financing in January.

New loans totaled 1.32 trillion yuan ($216 billion) compared with 482.5 billion yuan in December, slightly more than expected.

PBOC figures show that the rebound in bank loans in January was driven by mid- to long-term corporate loans, which jumped to 826.2 billion yuan from 305.1 billion yuan in December, reflecting strong credit demand.

Zhu Haibin, chief economist in China at JPMorgan Chase & Co, forecast that benchmark interest rates and reserve requirement ratios will remain unchanged but credit tapering will continue, which points to a tightening bias.

Zhu noted that total social financing growth, which stood at 17.8 percent in the second half of last year, is expected to moderate to 16.2 percent in 2014.

Since May, Zhu said, the three-month Shanghai Inter-bank Offered Rate has climbed about 170 basis points - the rate stood at 5.5585 percent on Tuesday - which pushed the one-year government bond yield up about 110 bps.

The average bank lending rate rose by 29 bps in the second half of 2013, although average underground lending rates were stable.

"If there is a delayed pass-through effect, business borrowers will face higher funding costs in the coming months. That will hit business sentiment and drag on economic growth," Zhu said.

With credit tight, domestic companies are now paying more than 10 percent interest rates on bank loans. Private loans are even more costly, with interest rates higher than 20 percent.

It's a lot cheaper to borrow overseas. For example, State-owned China Oil and Food Import and Export Corp has issued five-year, US dollar bonds with a coupon of 3 percent. Baosteel Co Ltd issued five-year dollar bonds as well, with a coupon of 3.75 percent.

According to capital markets data provider Dealogic (Holdings) Plc, the amount raised by Chinese companies in Hong Kong and the United States rebounded to its previous record level in 2013 after a two-year drop.

That suggests a slow recovery in investor confidence after the global financial crisis.

In 2013, Chinese companies issued $49.7 billion in general purpose bonds overseas, compared with $29.7 billion in 2012 and $25.9 billion in 2011.

Dealogic said that as of mid-February this year, Chinese real estate companies had issued $7.9 billion in dollar-denominated bonds, accounting for 38 percent of the world's total real estate debt.

Some analysts have forecast that Chinese companies may start to issue more dollar-denominated bonds after releasing their first-quarter results to lock in low interest rates.

Interest rates are expected to rise as the US Federal Reserve Board tapers its quantitative easing policy.

"While there is a risk of a messy unwinding as the Fed's funds target rate rises, we do not believe that China's leverage problem is external, but it is a domestic chal-lenge," said Green.

"Even if US dollar exchange rates rise in 2016 and 2017, assuming healthy domestic growth, there should be no need for the outstanding debt to be unwound," he said.

Green added: "There is a widespread view that the default risk of China's large financial institutions is extremely low."