US interest rate rises set to expose China’s frailties
The world’s most leveraged corporate sector adds to the country’s vulnerabilities
As Washington steels itself for the arrival of Donald Trump and a rise in interest rates, China could be forgiven for feeling itself besieged.
The country is home to the world’s most leveraged corporate sector, a notoriously volatile property sector and a swath of banks that depend on borrowing on the money markets to fund loans.
That makes the Chinese economy particularly sensitive to expectations of increasing interest rates, which together with the strong US dollar since Mr Trump’s election, have already sparked a rush to sell emerging market bonds and stocks.
“I think the Trump factor [will result in] more aggressive hiking of US interest rates, not just the one expected in December but also several times next year,” said Shen Jianguang, chief economist at Mizuho Securities in Hong Kong, speaking ahead of the Federal Reserve meeting which is widely expected to raise rates next week.
“A stronger US dollar will complicate the Chinese government’s efforts to stabilise the renminbi exchange rate and Beijing may have to tighten monetary policy,” he added.
The vast size of China’s debt mountain — which stands at over 250 per cent of gross domestic product, up from 125 per cent in 2008 — means that even minor increases in short-term interest rates may squeeze corporate activity and precipitate defaults, thereby hampering economic growth.
Alex Wolf, emerging markets economist at Standard Life Investments, argues that default risks are rising because more and more corporations are relying on the short-term money market to raise the finance they need to repay existing debts.
“Rising rates, especially short-term, increases the stress on weaker companies and raises the risk of defaults, he said. The six-month Shanghai interbank offered rate, a benchmark short-term interest rate, has surged in recent weeks as monetary conditions have tightened.
Estimates by Fitch, the rating agency, reveal a level of pain in corporate China that is not hinted at by official statistics. Some 15 per cent to 21 per cent of loans in the Chinese banking system are already non-performing, Fitch estimates, compared with official numbers of less than 2 per cent.
Against this backdrop, an upsurge in Chinese capital outflows, which reduced foreign exchange reserves by nearly $70bn in November, intensifies the challenges facing Beijing. With money pouring out of China, Beijing has little choice but to tighten domestic monetary conditions in spite of the difficulties for companies already unable to service their debt.
The Institute of International Finance, a global association of financial institutions, calculates that in the first 10 months of this year net capital outflows from China totalled $530bn, with October marking the 33rd straight month in which more money left the country than flowed in.
A strong dollar makes US assets more attractive relative to those held in a depreciating renminbi, prompting the Chinese to search for ways around recently-strengthened capital controls to send their money offshore.
The rise in short-term interest rates might also hit one of the weakest pillars in China’s financial architecture. Several midsized banks, such as the Bank of Jinzhou, find it hard to attract deposits and rely, therefore, on borrowing from the short-term money markets — but the cost of such borrowing is now rising.
Property companies — a mainstay of the wider economy — are also acutely vulnerable to the surge in short-term rates. Bond issuance by developers has plummeted since authorities tightened rules in October to rein in an overheated market, crimping their ability to invest in new projects.
In November, property developers issued only Rmb12bn ($1.7bn) in bonds, down from a monthly average of Rmb86bn from January to September, according to FT Confidential Research, a unit of the Financial Times.
Such economic stresses are complemented by the raft of political uncertainties that attend Mr Trump’s accession to the White House. He has threatened to slap tariffs on Chinese exports to the US and label Beijing a “currency manipulator” because of charges that the renminbi is undervalued.
“Is Donald Trump looking for a foreign enemy to redirect the attention of his supporters as he implements a plutocratic fiscal agenda with his plutocratic cabinet?” said Gary Greenberg, head of emerging markets at Hermes Investment Management, a fund.
A telephone call last week between Mr Trump and the leader of Taiwan, with which the US has no diplomatic relations, has also strained relations.
“The Taiwan call, along with undiplomatic tweets, gives [Mr Trump] a far away enemy who can be targeted as the source of US ills,” Mr Greenberg said. “China can react very angrily. Could this escalate? Possibly, but it is a little early to say.”
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