Cheer reflected in 15% MSCI stock market index leading gains pervades China’s “V-shaped” recovery in the hope the world’s second largest economy is leading a global post-pandemic turnaround.  Investors point to strengthening currency, and positive official and non-official purchasing managers’ indices, with the services sector rebounding sharply in August as the economy largely re-opened. The IMF predicts China will be one of the few economies to expand this year.

However, China entered the Covid-19 pandemic with crushing debt that has worsened.  The Institute for International Finance, in its most recent estimate, put total debt/GDP at 317%, with the non-financial corporate total above 250%, the world’s largest. In addition, household debt/GDP is nearing 60%, triple the level just a decade ago.  Within that category credit card debt has soared more than 80% in less than four years. Through July total social financing, a broad measure of credit that includes bonds and off-balance sheet financing, was up 12.9% on an annual basis and stood at nearly 90% of 2019’s full year total.

For banks, the largest holders of corporate bonds domestically as well as issuers, the build-up of debt accelerated despite corporate deleveraging in recent years, and worsened in the first half. Government pressure to lend to ailing small business and defer loan payments during the worst of the pandemic outbreak battered the USD 45 trillion banking system.  The “Big 4” banks all reported profit down at least 10% in the first half, while they hiked loan loss provisions in Q2 by 61%-436%, according to data from China International Capital Corp.  The China Banking and Insurance Regulatory Commission reported that commercial banks recorded a 9.4% drop in H1 net profit, with the average non-performing loan ratio at 1.94%, the highest since the GFC while widely considered understated by international standards. The 20 mid-sized and small commercial banks listed in Hong Kong set aside more cash as loan loss provisions than they earned in net profit in H1, according to calculations by Standard and Poor’s.

Bond defaults onshore were down 17% in the first half under contrived conditions, with direction  and pressure from Beijing to refinance, delay payments, and swap debt due for paper with longer maturities. In July and August default levels rose and pressuring is growing as some USD 530 billion matures by year-end.  In the offshore dollar market, defaults have already exceeded 2019’s full-year total by 55% according to Bloomberg. The riskiest bonds on- and off-shore are property developers, which issued USD 6 billion offshore in July alone, up 33% from the same month last year in an attempt to meet upcoming payment obligations. The sector needs to refinance or pay nearly USD 30 billion of domestic bonds and USD 12.3 billion of offshore notes through year-end, according to Bloomberg data, as the central government plans to restrict real estate issues above threshold financial ratios.

As in many countries, the end of loan repayment standstills was extended until March 2021, but banks will have to continue to increase provisioning for loan losses through then, further denting profits. Already Beijing has allowed one small bank to go under this year, and debt laden local governments – which have issued more than USD 360 billion in on- and offshore bonds so far this year – have been asked to help prop up ailing local financial institutions. Bond defaults in yuan and dollars are expected to spike after corporate debt climbed 13%-points in H1 to 164.4% of GDP, according to official data. While broad GDP, PMI, and exchange rate data may appear promising, the underlying debt drag in Western alphabet terms readily rewrites the V resurgence as a partial W.

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