China has struggled with bad debt for several years now, with excessive leverage threatening the financial viability particularly of state owned enterprises. The Financial Times noted recently that bad debt disposals have reached levels not witnessed for twenty years. Non performing loans amounted to 1.75 trillion Renminbi (or $258 billion dollars) last year. Non-performing loans reached 1.89% at the end of 2018, which marked a ten year high.
China's deleveraging campaign has strived to bring down these high levels, with top officials viewing high levels of debt as a threat to financial stability. The campaign hasn’t been aimed at stopping funding entirely—rather, the main focus of the deleveraging campaign is to eliminate firms with overcapacity and zombie firms.
This bad debt has become attractive to some. Last year, a number of foreign investors purchased distressed debt portfolios. To assist this process, In May 2018, the State Administration of Foreign Exchange permitted commercial banks and asset management companies to sell non performing loans to foreign investors through the Shenzhen Qianhai Financial Assets Exchange.
China’s national and provincial asset management companies assist banks in offloading bad debt from the books. This has helped to keep China’s non performing loan ratio relatively low.
Chinese banks have attempted to tighten credit to some extent in order to support the deleveraging process. Some analysts have suggested that the deleveraging campaign has shifted the debt burden from the state sector to the private sector by pinching private firms. In addition, private firms have suffered as regulations crack down on shadow banking, an alternative financial market to which companies were previously able to turn when they couldn't obtain bank financing.
The government also opened the Central Bank Bill Swap to replenish Tier 1 capital. This permits primary dealers of open market operations to trade their perpetual bonds for central bank bills. Swap agreements will last for under three years.
However, this doesn’t mean that loan losses are ending. In fact, due to the economic slowdown and trade war, losses in general have been mounting. Hundreds of listed companies issued profit warnings in January. The losses come from hog farmers facing difficulties in purchasing feed as well as glassware makers who cannot collect receivables.
At present, several sectors are at risk of being able to repay interest, including infrastructure, transport and equipment, machinery, utilities, and real estate. These industries have a relatively high ratio of interest payments to earnings before interest and taxes.
Despite all the policy priority given to deleveraging, it was reported last year that Chinese non-financial corporate debt was on the rise in the first quarter of 2018 compared to the final three months of 2017. This reveals that deleveraging hasn’t been an easy process for China. Bad loans continue to be created as state owned firms enjoy implicit state guarantees and interest rate controls. In other words, the fundamental reasons for creation of bad debt remain in place. In addition, the backtracking on deleveraging reveals that the government still holds economic growth above deleveraging as the ultimate goal. What this means is that it’s like deleveraging campaign is likely to march on, in the short run and possibly the medium run as well.
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