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Business trends

China's corporate bond defaults tripled to $8.7bn in first half

Private sector hit hard by unregulated expansions and economic slowdown

A commercial complex operated by Yinyi in Shanghai: The property developer defaulted on 700 million yuan in interest payments for bonds issued in 2016. (Photo by Yusho Cho)

SHANGHAI -- Chinese corporate bond defaults are expected to hit record highs this year, a worrying trend for President Xi Jinping as he steers trade negotiations with the U.S.

Defaults on corporate bonds came in at slightly over 60 billion yuan ($8.7 billion) in the first six months of the year, at a pace almost comparable to fiscal 2018 when record defaults were logged.

Beijing reversed its policy of cutting debt in the second half of 2018 as the trade dispute with the U.S. intensified, but analysts say many businesses were already facing financial difficulties due to unregulated expansion policies and an economic slowdown. Total debt by China's listed companies at the end of March swelled to 38 trillion yuan.

In June, property developer Yinyi defaulted on interest payments on 700 million yuan of bonds issued in 2016. Zhejiang Province-based Yinyi had rapidly expanded its business in recent years, managing properties in Nanchang, Jiangxi Province, Shenyang, Liaoning Province and South Korea as well as buying an auto parts maker. But Yinyi has not been able to recoup its investments.

The company has issued three other rounds of bonds, for a total of 1.1 billion yuan, with timely redeemptions at maturity seen as unlikely.

At a multipurpose complex in southern Shanghai operated by Yinyi, most apartments have been sold, and a commercial complex with tenants including McDonald's, Domino's Pizza and a local supermarket is operating almost as usual.

An employee said he was aware of the parent company's predicament, but he had not heard from management and was not in a position to abandon the job.

Defaults on corporate bonds nearly tripled from a year earlier in the first six months of 2019, according to research company Shanghai DZH. The amount had slowed compared with the July-December period last year, but bond redemptions tend to increase toward the end of the year.

If such redemptions increase at the same pace as the first half of the year, corporate bond defaults are likely to match last year's record 122 billion yuan. S&P Global Ratings Senior Director of Corporate Ratings Cindy Huang said that roughly 6 trillion yuan of onshore bonds are due to either mature or become puttable this year, weighing on the second half.

The Hong Kong-based analyst added that Chinese corporations will face a liquidity squeeze in the second half. Huang said the funding environment has worsened after the government takeover of Baoshang Bank, a private lender in Inner Mongolia, end-May. Beijing's move, the first such in 18 years, created "volatility in the funding market and the interbank market, which has spilled over to corporate sector funding," she said.

Corporate debt defaults were rare in China until around 2015, as local governments typically came to the rescue of financially troubled companies, especially state-owned enterprises. Fearing massive job losses, local administrations leaned on banks to provide financing to help keep such companies afloat.

But things started to change in 2016, when President Xi's government embarked on radical restructuring to burn off excess production capacity. The policy led to a wave of corporate bond defaults.

The government temporarily returned to focusing more on stoking economic growth in 2017, announced during the Communist Party's national congress, an all-important twice-a-decade political conclave.

In 2018, however, the Xi administration started afresh reining in expansion of corporate financing under a "deleveraging campaign." As a result, the total amount of corporate defaults tripled in 2018 from the previous year.

The escalating trade spat with the U.S. prompted the Xi administration to change its policy stance and refocus its economic policy again on stimulating growth in the second half of 2018, urging banks to ramp up lending to prevent corporate bankruptcies. S&P's Huang said, though, that small regional banks' lending capacity would be constrained, after overextending over the past few years.

With the new government direction, corporate defaults have not declined significantly, as many Chinese companies piled on debt to finance their aggressive business expansion, often through costly acquisitions.

Chinese food and daily product maker Reward Group, known as Luowa in Chinese, recently defaulted on 450 million yuan in bonds after years of rapid expansion through debt-financed acquisitions in the U.S. and France.

Although bank lending grew by more than 8 trillion yuan in the first five months of 2019, under the Xi administration's drive to rev up the economy, the lion's share of the credit has gone into state-owned businesses.

According to Shanghai DZH, a provider of online financial information services, state-owned enterprises accounted for only five of the 70 corporate defaults that occurred in the first half of 2019. Beijing-controlled companies constituted 16 of the 124 defaults in the entire 2018. The data point to deepening woes among private-sector companies.

The government's aid to help finance troubled businesses could end up worsening the problem of over-borrowing by allowing heavily indebted companies to run up even more debt.

The total debt of the 3,500-plus companies listed on Chinese stock exchanges (excluding financial institutions) surged 130% in the six or so years since Xi became the nation's supreme leader at the end of 2012, when it stood at 16.6 trillion yuan.

After slowing down in the first half of 2018, growth in corporate debts has returned to its previous torrid pace, running at annual clips of over 10% at the moment.

The government's spending on public investment is also partially financed by corporate borrowing. While the government likes to use a so-called "public-private partnership" approach in infrastructure investment to tap private-sector funds, the number of promising PPP projects with solid profit prospects is declining.

Signs are emerging of problems with the government's debt-oriented approach to shoring up the flagging economy. Nanjing Jiangong Group, a Nanjing-based construction firm that has been involved in many PPP projects, also recently defaulted on its debt.

Nikkei Asian Review chief business news correspondent Kenji Kawase in Tokyo contributed to this story.

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