How much more debt can China take? (Keystone)

Debt

Will debt drag down China? 11 May 2016, written by Kelvin Soh

The rapid accumulation of corporate debt in China has become a concern for global investors. The economy has started to stabilize, says UBS CIO, but the debt problem is not going away any time soon.

Non-financial corporate debt stood at about 170 percent of GDP in the third quarter of 2015, up from just under 100 percent at the end of 2008, according to the Bank for International Settlements. China's total debt-to-GDP ratio may exceed 300 percent by 2020, according to UBS forecasts.

China's leadership has noticed the problem, with Chinese state media saying that "high leverage is considered the cause of financial risks". The country may need to abandon the idea of relying on monetary expansion to solve structural problems, the official People's Daily reported, citing an interview with a "person of authority".

This is the third time a "person of authority" has spoken about economic policy in the past year, and is widely believed to represent the central Chinese leadership.

China has already started taking steps to ease the debt problem, said Hu Yifan, Regional CIO for Greater China. For example, domestic media has reported that the Chinese government might initiate a debt-to-equity swap programme that could last three years and amount to 1 trillion yuan.

"However, debt-to-equity swaps might be a short-term fix to buy the economy more time, but they're not a long-term cure to solve overcapacity and the lack of profitability in key industries," said Hu. "Instead, non-performing loans should be handled more transparently and with innovative, market-friendly measures."

Supply-side reform has become a key focus, and looks to address overcapacity, destocking, deleveraging, and cost reduction. Already, a batch of three to five state-owned enterprises has been selected for pilot reforms. Indeed, the "person of authority" quoted by state media said that companies "that need to be closed should be closed", and the government should focus on re-training.

"Given the challenges in implementing supply-side reform and its lengthy process, we recommend investors to focus on companies with a solid fundamental business outlook and potential reform," said CIO analyst Louisa Fok.