Expectations towards China's leadership to address indebtedness at the corporate level are building ahead of the ruling party's third plenum later this week. Observers offer different views on how access to funding can be made easier for profitable companies.
"Now is the time for big bang reforms, not tinkering," urges Ben Simpfendorfer, founder of Hong Kong based-consultancy firm Silk Road Associates and former chief China economist at the Royal Bank of Scotland. "There are serious issues that need to be addressed, such as land rights, corporate transparency and credit allocation."
He believes specific reforms are unlikely to be announced at the third plenary session of the 18th Communist Party of China's Central Committee, to be held November 9-12 in Beijing, adding that interest rate liberalization will be insufficient to divert funds away from leveraged state-owned companies (SOEs) to the growing private sector.
"In a state-dominated banking sector, no one loses lending to large SOEs. While profit margins suffer from liberalized interest rates, you have to counter this with the fact that banks lending more to the private sector may start taking capital losses - that's a career killer. What is needed is a more fundamental reform, including better transparency, data protection and centralized credit reporting agencies."
"If a state bank is faced with the choice today to lend to a private SME or a huge SOE, they will always go with the latter. At least they can assume the government will bail them out."
Simpfendorfer spoke at the sidelines of the Latham & Watkins Asia Restructurings Summit, held Tuesday in Hong Kong. Mark Austin, who is chief executive officer of the Asia Securities Industry & Financial Markets Association (ASIFMA), a co-organizer of the event, believes that "given the economic climate in Asia, an increasing number of corporates will default in the next six to 12 months [accompanied with a] spike in restructurings."
"In particular, we see a pressing need to discuss issues surrounding China's potentially looming credit crunch," he added.
China's corporate debt level is high by international standards. According to a September research by BBVA, combined SOE and private sector debt amounted to 127% of GDP at the end of 2012 compared to an average of 70% for other emerging markets and up from 95.7% just four years earlier. The Bank of International Settlement estimates the figure to be 139.3%.
The largest funding source for these corporates has been bank loans, which contribute at least two-thirds to the mix. "If all the financing clusters are around bank loans, there is a lot of systemic risk created," thus highlights Frances Cheung, senior strategist for Asia ex Japan at Credit Agricole CIB during a panel discussion. "A whole spectrum of interest rates in China does not yet exist. Banks are only willing to lend to large SOEs at relatively low interest rates. [Others tap] less formal funding channels, including shadow banking and the high yield USD offshore bond markets."
Shadow banking funds 24% of corporate debt in China, compared to only 11.5% of financing coming from the domestic bond market and even less from the local equity market. Ji Liu, partner at law firm Latham & Watkins in Hong Kong, points to a growing number of first time issuers that are driven outside of China to raise debt capital offshore at high interest rates. Chinese property developers, for instance, had raised more than US$13.5 billion at mid-year 2013, trumping whole year issuance last year. If the market slows, he notes, these companies likely face serious cash-flow problems.
Providing these issuers with more choices of funding is critical for the health of the economy, Liu believes. He suggests "opening the domestic bond market up to more foreign investors would definitely increase liquidity in the market and increase competitiveness", adding that repatriation restrictions of bond proceeds raised internationally should be loosened.
Chinese issuers tapping markets abroad suffer from skepticism on part of investors unsure how to recuperate value in case the company ceases to exist, weighs in Latham & Watkins partner Bryant Edwards: "The famous Asia premium [issuers from the region need to pay] rises in large part because bankruptcy regulations and procedures frankly are not ideal … A better legal framework is needed to minimize the destruction of value that often occurs in distressed situations in Asia."