China may have to brace for a new wave of bond defaults, S&P said

BEIJING – China’s state-run economy could be setting the conditions for a new wave of bond defaults that could come as soon as next year, according to a report from S&P Global Ratings published Tuesday.

It would be the third round of corporate bankruptcies in about a decade, the rating agency said.

This comes against the backdrop of extremely low defaults in China and concerns about the overall growth of the world’s second-largest economy.

“The real thing to watch for policymakers is whether the current guidance creates distorted incentives in the economy,” Charles Chang, leader of the larger Chinese country at S&P Global Ratings, said in a telephone interview on Wednesday.

China’s corporate bond default rate fell to 0.2% in 2023, the lowest in at least eight years and well below the global rate of around 2.6%, S&P data showed.

“To some extent this is not a good sign, because we see this divergence as something that is not the result of the functioning of the markets,” Chang said. “We have seen guidance and guidance from the government over the past year to discourage defaults in the bond market.”

‘The question is: when should the guidelines avoid defaults in the bond market? [ends]What’s happening with the bond market?,” he said, noting this is something to watch for next year.

In recent years, Chinese authorities have emphasized the need to prevent financial risks.

But heavy-handed approaches to tackling problems, especially in the real estate sector, can have unintended consequences.

The property market slumped following Beijing’s crackdown on developers’ heavy reliance on debt over the past three years. The once-great sector has dragged down the economy, while the real estate sector shows little sign of turning around.

According to S&P, real estate led the last wave of defaults between 2020 and 2024. Previously, their analysis showed that industrial and commodity companies led the defaults from 2015 to 2019.

“The bigger issue for the government is whether the real estate market can stabilize and property prices stabilize,” Chang said. “That could potentially mitigate some of the negative wealth effects we’ve been seeing since the middle of last year.”

Much of household wealth in China is tied up in real estate, rather than other financial assets such as stocks.

Bond defaults fell last year in most sectors except tech services, consumer and retail, S&P found.

“That points to potential vulnerabilities to the slowing growth we’re seeing now,” Chang said.

China’s economy grew 5.2% last year and Beijing has set a target for GDP growth of around 5% in 2024. Analyst forecasts are generally near or below that pace, with expectations for a further slowdown in coming years due to the double-digit numbers. growth in recent decades.

China’s large public, private and hidden debts have long raised concerns about potential systemically important financial risks.

However, China’s debt problems are not as pressing as the need for Beijing to address real estate issues in a broader “comprehensive strategy,” Vitor Gaspar, director of the International Monetary Fund’s fiscal department, said at a meeting of the International Monetary Fund . press conference last week.

Other aspects of the strategy, he said, include China’s emphasis on innovation and productivity growth, as well as the need to strengthen social safety nets so that households will be more willing to spend.

It remains to be seen whether other sectors can offset the negative impact of the real estate sector on the economy and strengthen overall growth.

UBS upgraded MSCI Chinese shares to overweight on Tuesday on better corporate earnings that are unaffected by real estate market trends.

“The largest stocks in the Chinese index have generally performed well in terms of earnings and fundamentals, so China’s underperformance is purely due to the collapse in valuation,” said Sunil Tirumalai, chief GEM equity strategist at UBS, in a note. “What now makes us more positive about the profit figures are the first signs of a recovery in consumption.”

The bank also raised its outlook for Hong Kong stocks.

On why UBS changed its view on Chinese valuations, Tirumalai pointed to a “growing trend of Chinese companies delivering positive dividend/buyback surprises.”

“This increased visibility of shareholder returns could be useful as global markets become more concerned about geopolitics, and in longer-term scenarios. We would keep an eye on the next phase of market reforms,” he added.