Domestic debt has long been an issue for the Chinese economy. But one particular corner of the debt market—dollar-denominated debt issued by Chinese companies—looks increasingly in danger of collapse.
Several factors are contributing to the rising risk of default. Rising interest rates, a declining Chinese currency, the ongoing U.S.–China trade dispute, and fast-approaching maturities are causing experts to sound the alarm.
“We will be talking about a major financial crisis—a dollar debt crisis,” Daiwa Capital Markets’ Kevin Lai told the South China Morning Post. Lai is the securities firm’s chief economist for Asia (excluding Japan).
There’s $3 trillion in outstanding dollar-denominated debt issued by Chinese companies, Daiwa estimates; most was issued by subsidiaries of Chinese companies in Singapore or Hong Kong.
So why did China Inc. issue so much dollar debt?
For one, it’s become difficult in recent years for Chinese private companies to issue onshore debt, due to Beijing’s crackdown on leverage. In addition, issuing dollar-denominated debt opens up a whole new group of buyers—foreign investors. Offshore dollar debt also offered companies lower yields than onshore yuan debt. Lastly, dollar-denominated debt is simply easier to use to fund foreign-asset purchases and bypasses Beijing’s capital-flow restrictions.
Defaults on dollar-denominated Chinese bonds stood at $3.4 billion in the first 10 months of this year, Japanese investment bank Nomura wrote in a research note earlier this month, according to CNBC. In 2017, no dollar bond defaults had been recorded through October.
Nomura expects more defaults going forward “against a backdrop of weakening domestic demand, rising credit defaults, a depreciating RMB and Fed rate hikes.”
This is because more bonds are coming due. About $33.3 billion in dollar-denominated Chinese bonds are expected to mature each quarter through the end of 2020, which is a much higher pace than the $11 billion in maturities through Q3 this year.
Multitude of Risks
Chinese companies had valid reasons to issue dollar debt: It was inexpensive, and companies enjoyed a good spread between low-cost debt and high-yielding yuan assets, especially when the Chinese real estate market was still hot. It also made sense when the dollar-yuan exchange rate was largely stable. But issuing debt in a foreign currency is difficult to manage and requires complex hedging.
Given that the yuan has fallen about 6 percent against the dollar year-to-date, Chinese companies with dollar debt will be at a disadvantage.
For example, a $100 million bond paying an 8 percent coupon cost a Chinese company 52.8 million yuan in annual interest when the USD–CNY exchange rate was 6.6. If the yuan weakens by 6 percent against the dollar, however, then the annual interest cost would increase by 3 million yuan to almost 56 million yuan per year.
In essence, interest costs have risen for Chinese companies at a time when the domestic economy is sputtering and an ongoing trade war is hurting revenues.
And such context is important. A strengthening dollar on its own isn’t an issue, but foreign exchange headwinds have become another pain point for Chinese companies already facing mounting domestic debt. The problem is especially acute for Chinese property developers, which have gorged on debt—both in dollars and yuan—in recent years. But the industry is facing a high so-called “maturity wall,” or debt becoming due, in 2019.
Data from Dealogic shows that 385 billion yuan ($55 billion) of local-currency debt and $15 billion of dollar debt will come due next year for Chinese property developers, according to a Financial Times report.
But refinancing, which is likely the only option for most developers besides defaulting, has become increasingly difficult and costly.
In past years, property developers were able to tap into funding through the shadow banking industry. But recent crackdowns by Beijing have eliminated most options there.
Capital market funding costs have gone up in recent issuances. Bloomberg data has shown that yields on Chinese below-investment-grade borrowers have reached 4-year highs. Last week, Times China Holdings Ltd. and Hengda Real Estate Group Co. both priced two-year dollar offerings at an eye-wateringly high rate of 11 percent.