Record Debt by Chinese Companies Puts Bank of China Tough Choices

On the one hand, the Bank of China wants to limit the growth of companies' debt burden, and on the other hand, an increase in rates by only 1% will eat up 30-40% of their profits.

The market continues to regard good macroeconomic statistics on China as bad news. Despite strong PMI numbers, China's CSI 300 declined on Wednesday and became the only one of the world's largest stock indices to go negative for the year.

Investors fear that the Bank of China will raise rates to prevent local companies from incurring excess debt. China's total public and private sector debt rose 29% last year to 315% of GDP, Citigroup calculated. Most of the money was borrowed by companies and provinces of the Middle Kingdom during the coronavirus pandemic.

Ironically, it is this huge debt that is hindering monetary tightening. These leveraged companies are vulnerable to rising interest rates and tightening financial conditions.

Citi economists found nearly 600 Chinese companies with 20% higher leverage than the industry average. Their combined market capitalization is about 11 trillion yuan ($ 1.7 trillion), or 17% of the total capitalization of the Chinese stock market.

Assuming that most of their debt is bank loans, each 1% increase in interest rates would increase their loan payments by 152 billion yuan, the equivalent of 30% of their profits.

Developers are the most vulnerable given their high level of debt burden and the uncertainty associated with regulatory policies aimed at limiting the ability of indebted companies to attract new loans. A 1% rise in interest rates will eat up about 42% of developers' profits.

"The growth of debt burden (of Chinese companies - approx. ProFinance.ru) raises concerns, but it will definitely need to be taken into account when the Bank of China begins to roll back monetary stimulus measures," Citi analysts write. "If we do not exercise due caution, we will not only see the Chinese version of 'taper tantrum' *, but also the growing risks of default by these debt-laden companies."

* 2013 market panic. Then the rapid growth of ten-year Treasury yields by about 0.8% was caused by expectations of a premature tightening of monetary policy by the Federal Reserve.

It looks like, starting today, the Bank of China will have to balance on a tightrope.