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Chinese borrowers are taking on record amounts of debt to repay interest on their existing obligations, raising the risk of defaults and adding pressure on policy makers to keep financing costs low.

The amount of loans, bonds and shadow finance arranged to cover interest payments will probably rise 5 percent this year to a record 7.6 trillion yuan ($1.2 trillion), according to Beijing-based Hua Chuang Securities Co., whose lead fixed-income analyst Qu Qing was top-ranked by China’s New Fortune magazine in 2012 and 2013. Dubbed “Ponzi finance” by Hyman Minsky, the use of borrowed funds to repay interest was seen by the late U.S. economist as an unsustainable form of credit growth that could precipitate financial crises.

Chinese companies are struggling to generate the cash flow needed to service their obligations as economic growth slows to the weakest pace in 25 years and corporate profits shrink. While the debt burden has been eased by six central bank interest-rate cuts in 12 months and a tumble in corporate borrowing costs to five-year lows, the number of defaults in China’s onshore corporate bond market has increased to six this year from just one in 2014.

“Some Chinese firms have entered the Ponzi stage because return on investment has come down very fast,” said Shi Lei, the Beijing-based head of fixed-income research at Ping An Securities Co., a unit of the nation’s second biggest insurance company. “As a result, leverage will be rising and zombie companies increasing.”

Latest Failure

China Shanshui Cement Group Ltd. became the latest company to default on yuan-denominated domestic notes last week as overcapacity in the industry hurt profits and a shareholder dispute stymied financing. State-owned steelmaker Sinosteel Co., which pushed back an interest payment on a bond last month, postponed it again this week.

Metrics of corporate health in Asia’s largest economy have deteriorated as growth slowed. The number of Shanghai and Shenzhen-listed companies that have less cash than short-term debt, net losses and contracting revenue has increased to 200 as of June from 115 in the year-earlier period, according to data compiled by Bloomberg. The amount of bad debt among Chinese banks rose 10 percent in the third quarter from the previous three months to 1.2 trillion yuan, about the size of New Zealand’s economy.

Borrowings Climb

Total debt at listed companies has climbed to 141 percent of common equity, based on a market-capitalization weighted average, the highest level in three years.

While the total amount of debt issued to pay interest is projected by Hua Chuang Securities to increase, it’s taking up a smaller portion of overall new credit. The firm predicts such borrowing will account for 45 percent of new total social financing -- which includes bank loans, shadow banking credit and corporate bonds -- down from 50 percent last year, according to a Nov. 4 report.

Plunging borrowing costs have made it less expensive for Chinese companies to gain access to fresh cash. The rate on five-year corporate debt with AAA ratings dropped to a five-year low of 3.69 percent on Oct. 29 and was last at 3.95 percent.

At the same time, policy makers are taking steps to insure credit keeps flowing to borrowers in need. Chinese banks shouldn’t cut or withdraw lending to companies in “temporary” difficulties, Premier Li Keqiang said last month, adding that the government will take steps to prevent systemic risks. The People’s Bank of China has cut its benchmark one-year lending rate to 4.35 percent from 6 percent a year ago, helping to fuel 6.6 percent growth in outstanding corporate bonds this year to 19.2 trillion yuan as of October.

Defaults Forecast

“The lower funding rates have lessened the interest burden on Chinese companies,” said Xia Le, a Hong Kong-based economist at Banco Bilbao Vizcaya Argentaria SA.

Defaults will probably keep rising as profits fail to keep up with interest expenses at some Chinese borrowers, according to Zhou Hao, a senior economist at Commerzbank AG in Singapore. Earnings at Chinese industrial firms shrank for a fourth straight month in September, while producer prices fell for the 44th consecutive month in October. China’s economic growth will probably slow to 6.9 percent this year, the weakest pace since 1990, from 7.3 percent in 2014, according to economist estimates compiled by Bloomberg.

“We will see more defaults and rising bad loans in the financial system,” Zhou said.

— With assistance by Lianting Tu, and Judy Chen