China Corporate Debt is the Problem

A commentary in the No. 1 Financial Daily newspaper says that international investors' concerns about China's government and "shadow banking" debt are misplaced. The real problem, says the paper, is corporate debt which totaled 6.5 trillion yuan at the end of 2012. The paper said corporate debt is the largest, fastest-growing, and most-risky segment of debt in China. Corporate debt is equal to 122-127 percent of China's GDP, a ratio that is double the 50-70 percent ratio in OECD countries. The paper called it a much more serious "hidden danger" than government or shadow banking debt.

The run-up in debt since 2008 results from heavy investment in fixed assets with low net returns. The debt is concentrated in real estate and construction sectors. The debt-asset ratio for companies listed as A-shares on China's stock exchange rose from 53 percent in 2008 to 60 percent now.

The debt of the largest companies has risen the fastest, more than 300 percent from January 2008 to June 2012. Large companies' earnings have also grown slower than earnings of smaller companies.

Vigorous investment created excess capacity that compounds the problem by reducing profitability and returns. Excess capacity is most serious in upstream heavy industries including steel, construction equipment, aluminum, coal, solar energy, and ship-building. According to the paper, corporate profits during 2012 were the lowest in several years and returns on investment have been less than borrowing rates over the past four quarters.

The article says the risk of a corporate debt crisis will increase for the foreseeable future. Much of the debt will mature in the next three years, but the article says pressure to make interest payments is greater than principal repayment.