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China and the Debt-Refinancing Game in 2017
Higher borrowing costs and weaker profits could be a combustible mix

By NATHANIEL TAPLIN
Updated Jan. 3, 2017 4:18 a.m. ET
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In 2016, China proved again how difficult it is to bet against the nation’s formidable credit-driven economy. The nation entered the Year of the Monkey with industry deep in deflation and firms rapidly shedding workers. A 3 trillion dollars credit jolt later, prices have rebounded, corporate profits are rising, and bond defaults have slowed sharply.

The results might seem impressive. But the cost has been substantial: even higher debt levels for state-owned firms and a dangerous rise in short-term borrowing just as the Federal Reserve begins tightening. With borrowing costs rebounding in 2017, firms will likely run into trouble again as the real-estate cycle winds down—this time with even more debt in play.

Facing a wall of maturing high-interest corporate debt in mid-2015, policy makers appear to have gambled that pumping up property and industry again would buy enough time for debt-addled state firms to refinance at lower rates.


In one sense, that gamble has paid off.

Real borrowing costs for industrial firms have plummeted as materials demand has returned and producer-price deflation has eased. And in the bond market, average yields for firms in troubled coal, steel and building materials sectors fell around 0.4% from mid-2015 to late 2016, resulting in more manageable debt-service burdens as firms refinanced.


The flip side of this success, however, is much higher debt in aggregate. Outstanding bond debt in “overcapacity industries” including coal and steel has more than doubled since May 2015 to 1.67 trillion yuan (240 billion dollars), figures from data provider Wind show.

The story is similar for the state-owned sector as a whole. Bonds issued by locally-owned state enterprises—a main locus of bad debt in the economy—paid a weighted average yield of around 3.8% in mid-December, down a full 4% from mid-2015. Their bond debt as a whole, however, nearly doubled to 15.4 trillion yuan over the same period. And troublingly, average maturities have also begun falling again since late 2015, suggesting that despite the efforts of the central bank, corporations are still becoming more dependent on short-term lending.

Bond are, of course, only part of the story in China where banks remain the heavy hitters. And for now, the damage to the real economy from China’s post-Fed credit market convulsions is likely to be limited because so many firms have already refinanced, and industry is relatively flush again.

But nothing lasts forever. As the real-estate cycle winds down and weakening profits collide with higher borrowing costs, bigger trouble in the credit markets looks likely to re-emerge.