China Credit Squeeze: Time to worry or listen to Goldman?
China analysts are ending 2016 in much the same way as they started it; by warning about the country’s rapidly deteriorating financial position.
After several months of calm, in recent weeks China credit concerns have begun to resurface. Several media outlets have drawn attention to the increasing number of onshore defaults and given the rapid pace of credit growth this year, the company’s corporate sector is now even more indebted than it was heading into 2016.
China Credit Squeeze: Goldman Is Not Worried
As the Wall Street Journal reported at the beginning of this week, a gradual tightening of short-term credit by China’s central bank prompted a mini-rout in the country’s $8 trillion bond market. Rumours of a liquidity squeeze at some brokers (Guangxi-based brokerage Sealand Securities Co., which has $7.2 billion in assets suspended trading in its shares following reports that it had taken large losses related to bond swaps) also weighed on credit investors and the cost of interbank funding within China has leapt to 3% (seven-day repo) in recent weeks compared to the 18 month average of 2.5%. Furthermore, both the 5yr and 10yr China government bond yields have risen by around 70bps since the end of October.
China Credit Squeeze
As usual, the Chinese authorities have acted quickly to control the market and settle investor nerves. Some $83 billion in short-term and medium-term funds were injected into the market at the end of last week.
Despite this massive capital injection, it is unlikely concerns about the state of China’s credit market will go away anytime soon. Some 40% of the asset in so-called wealth management products marketed to Chinese investors was invested in bonds as of the first half of 2016, up from 29% in 2015 according to Moody’s. Credit growth grew 20% year-on-year as of the second quarter of 2016 when including shadow banking. China’s total debt hit $27 trillion this year, 260% gross domestic product up from 154% of GDP in 2008. Researchers at the IMF estimate as much as 15% of the value of bank loans made to Chinese companies may now be worthless.
However, according to a research note published by Goldman Sachs earlier this week, the chances of a full-blown Chinese debt crisis in the near-term are slim:
“Given the sharp repricing in the bond market, there are worries that this will lead to broader financial instability. However, we strongly believe that policymakers’ ability to avert systemic risk and maintain financial stability is high, as (a) we believe that overall bond market leverage is relatively contained at around 1.5x, so while there could be problems among some of the higher levered structured products, overall bond market leverage is manageable, and (b) the PBOC has a number of tools at their disposal to inject liquidity into the financial sector, should they choose to alleviate the tightness in domestic liquidity.”
Overall, China managed to defy its critics in 2016 and Goldman believes it will continue to defy the doubters next year as well.
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