China’s sluggish growth may reignite bond default wave

Bloomberg

China had unexpected buoyancy in its economy to thank for an easing off in corporate defaults in the first half. But as growth shows signs of pulling back, the question is: will it last?
Despite alarm over the risks posed by China’s daunting debt pile ticking up in the first six months, the country actually saw a drop in corporate distress, with 0.27 percent of issuers defaulting, versus 0.55 percent in all of 2016, according to China Lianhe Credit Rating Co. Goldman Sachs Group Inc., too, saw Chinese company leverage drop in the first half.
Economists including Raymond Yeung at Australia & New Zealand Banking Group Ltd. put the improvement down to the economy, which seemed to turn a corner in late-2016. Growth accelerated in the fourth and first quarters, the first successive gains in seven years, which bolstered company earnings, says Yeung.
“The macroeconomic conditions are much more favourable to Chinese corporates compared with the same time last year,” Yeung said. “However, this cyclical adjustment will still face a limit. It is still too early to call the improvement a trend.”

Disappointing Data
And cracks may already be forming. Data showed growth in both retail sales and factory output slackened in July, coming in weaker than economists had anticipated. In the same Aug. 4 research note in which they detailed the decline in corporate leverage, Goldman analysts said defaults could pick up “as the pace of growth in the second half of 2017 slows.”
Beijing’s campaign to reduce overcapacity and re-orient the $11 trillion economy away from industrial and low-end manufacturing drivers has helped fuel profit growth this year, says Xia Le, chief Asia economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong.
But it’s “unimaginable” that the government will persist with the reform program while ignoring how it is affecting downstream industries, he said. “That’s why I expect profit growth to slow down.”

Profit Growth
China’s industrial profits have had a good run, growing 19.1 percent in June. The move to cut capacity has helped bolster commodity prices such as coal, steel and cement, and the recovery in those sectors—which saw the most bond defaults over the past two years—means banks’ asset quality is improving, Goldman analysts wrote in a note dated Aug. 3.
After the second-quarter read on Chinese gross domestic product came in better than expected, analysts boosted their forecasts for the coming quarters. The world’s second-largest economy will grow 6.7 percent this year, from a previous forecast of 6.6 percent, according to a recent survey.