By Anthony Harrington
The new leadership in the People's Republic of China seems determined to bring some sobriety back to the Chinese credit markets; but, as always-- when a government or central bank puts the squeeze on, many companies find themselves headed towards a brick wall. As the dominant engine of global growth, when China puts the brakes on, the pain really does get spread around. The signs of stress are starting to mount. As Bloomberg News reported on 12 March, a number of Chinese steel companies are having to cut back dramatically as they can't get the financing to keep running at their accustomed output levels. This, in turn, is leading to a glut of iron ore and to panic selling as providers frantically try to dump stock to free up cash.
On 11 March, China's top banking regulator warned that strict credit guidelines would be imposed on Chinese steel mills, particularly on those that are heavy polluters and consume large amounts of energy. Iron ore prices plummeted to a four year low in short order. However, the problem is not restricted to iron ore. As an article in the Wall Street Journal's Market Watch makes clear, the fact that the world price of copper dropped below $3 a pound for the first time since July 2010 can also be traced back to China, which is one of the biggest markets for copper.
And once again, the credit crunch is at the heart of the story. The Shanghai-based solar equipment manufacturer Chaori Solar became China's first ever mainland corporate bond defaulter, when it missed the interest rate payment on a domestic bond. Chaori Solar was already massively leveraged and said that, due to the ongoing credit crunch, it could not raise sufficient funds to make good on its interest payments. Now, a second solar energy company, Baoding Tianwei Baobian Electric, has had its bonds suspended on the Shanghai exchange after reporting substantial losses for the second year running, sparking fears of a default. In part, the default has a positive side in that it brings some much needed realism to the Chinese corporate bond market, which had been a magnate for investors who believed - erroneously as it now transpires - that the Chinese government or China's banks would always step in to bail out troubled companies. That belief had already caused the Chinese corporate bond market to bloat up 10-fold by the end of January 2014, to 8.7 trillion yuan, by comparison with where the bond market was in 2007.
However, the defaults and the tightening credit crunch have led to a falling away in financial transactions, which has hit the price of copper. Why? As Boris Schlossberg, managing director of FX strategy at BK Asset Management, writing for Investing.com points out, copper is used as collateral in many Chinese financial transactions, which has helped to keep the demand for copper high, even as industrial demand has slid. With the credit crunch knocking back financial deals, the synthetic demand for copper as collateral has fallen away sharply at the same time as industrial demand for the metal continues to be weaker than in prior years. With both copper and iron ore plummeting, the impact on the Australian dollar (with Australia being a major exporter of both metals) has been substantial, knocking 100 pts off the Aussie/dollar pair on 12 March.
However, all of this could just be the beginning. According to Standard & Poor's, Chinese corporate debt amounts to $13.8 trillion in 2014, more even than U.S. corporate debt. China's total debt-to-GDP ratio - despite its $4.2 trillion of reserves - amounts to over 200%. Are we standing on a cliff edge then? According to China, we are - but then they have been saying this for years and China has proved to be a lot more resilient than they expected. What is certain is that none of this is good and it makes for a very poor backdrop to Putin's Crimean adventure. The downside risks are growing, it seems...