The ratio of problem credit to total credit facing China's banks could triple to 17% by 2020, and banks may need to raise fresh capital of up to RMB11.3 trillion (US$1.7 trillion) if the growth of China's corporate debt does not slow, according to a report released by Standard & Poor's Global Ratings.
The amount of fresh capital needed to replenish Chinese banks is equivalent to 16% of China's 2015 nominal GDP, suggesting that the current growth rate of China's debt is not sustainable for long.
"Our base-case expectation is that the momentum of corporate debt growth, in particular, will persist for another two years," said Terry Chan, a credit analyst at S&P Global Ratings. "It should then ease as the Chinese
economy further re-balances from being investment- and heavy industry-led
toward one more reliant on consumption and services."
The rating agency's base case projection is for problem credit ratio to double to 10% by 2020 from its 2015 estimate of 5.6%. Problem credit is defined as nonperforming credit plus special mention loans.
"We expect leverage for China's top companies to increase further by the end
of 2016, and see limited prospect for improvement in 2017," said Christopher
Lee, a credit analyst at S&P Global Ratings. "We estimate the median debt-to-EBITDA ratio for our sample to increase to 5.0 times to 5.5 times, from about 4.8 times at the end of 2015."
The annual study of the top 200 companies in China shows that the leverage of
state-owned enterprises (SOEs) continued to increase as sluggish demand and
weak pricing more than offset a reduction in costs and capital expenditure.
SOEs comprise about 70% of the sample companies and 90% of their total debt.
The survey covers the leading companies or largest borrowers in 19 major
industry sectors in the country.
"We believe China's banks and financial system can withstand higher
non-performers. However, in the downside scenario where the current growth rate
continues unabated over the next five years, the likely rise in nonperforming
debt could place greater strain on the financial sector, possibly leading to
some bank recapitalization," explained Qiang Liao, a credit analyst at S&P
Global Ratings.
Since the global financial crisis, the debt-to-GDP ratio for China has grown
by a third, based on International Monetary Fund estimates. The debt ratio for
local governments, including local government financing enterprises, has grown by two-thirds. The debt ratio for households has increased by nearly half, the ratio for corporations has grown by nearly a third.
Meanwhile, the ratio for the central government has declined by nearly a third. In absolute terms, the corporate sector has consistently been the largest sector, representing 57% of total debt at end-2015.
The growth in corporate debt has been with the tacit approval of the central
government, given the dominance of the state-owned commercial banks in the
financial system, says the report.