What’s the size of Asia’s debt-funding task?
We estimate that Asia-Pacific’s non-financial corporate debt was US$24.2 trillion at the end of 2013, compared with US$14.1 trillion in North America and US$11.2 trillion in Europe. By the end of 2018, we expect the debt needs of Asia-Pacific will reach US$31 trillion — or more than half of the almost US$60 trillion in global refinancing and new debt needed.
Corporates in China make up the bulk of the current and future debt task. Indeed, China now has more outstanding corporate debt than any other country, having surpassed the US last year, a year sooner than we expected. We expect this gap to widen in the next five years. We expect that, through the end of 2018, the debt needs of corporate China, with its comparatively high nominal GDP growth, will rise to US$20 trillion, up from US$14.2 trillion at the end of 2013.
Is this increase in debt a concern?
Corporate credit globally has approached an inflection point as the center of gravity shifts to the Asia-Pacific region. With corporate debt in Asia-Pacific set to exceed that of North America and Europe combined by 2016, we believe this will lead to an overall increase in risk. In short, this is because the credit quality of corporate borrowers in Asia-Pacific is generally lower than in North America and Europe. Consequently, without improved risk assessment among investors and a heightened awareness by regulators of contagion risk, some future financial stress could stem from Asia.
Which countries are most vulnerable?
We have concerns about China’s rise in corporate debt. With China contributing an increasingly larger share, the financial risk of global corporate debt has increased in recent years and will continue to increase over the medium term. The debt increase in China has primarily gone into investments. However, the returns from such investments had been increasingly lower, resulting in weaker operating cash flow and earnings.
We estimate that more than one-quarter of China's corporate debt is sourced from its shadow banking sector. This means that as much as 10% of global corporate debt is exposed to the risk of a contraction in China's informal banking sector. This debt amounts to US$4 trillion to US$5 trillion. With China's economy likely to grow at a nominal 10% per year over the next five years, this amount can only increase.
Are some sectors riskier than others?
China's property and steel sectors remain of particular concern. The property sector's expansion is largely debt funded (forming part of the spike in Asian real estate debt). The funding comes partly from the shadow banking system, including peer-to-peer lending. Developers' debt appetite remains high, with many increasing their land bank and allowing property inventory to build. This oversupply has contributed to housing prices falling 10% this year, with a flow-on effect on construction steel demand. This demand fall-off is further pressuring steel producers already facing low domestic prices and chronic overcapacity. We expect more defaults in the steel sector. An external spillover from this has been the more than 25% fall in iron ore prices this year.
Given the substantial share that shadow banking contributes in financing not just China's corporate borrowers but also local and regional government financing vehicles, a sharp contraction would be detrimental for business generally. A contraction would particularly hit small-to-medium enterprises (SMEs), which have more limited access to bank financing.
Will this have flow-on implications outside of China?
The combination of weakened financial profiles, slower economic growth, tighter access to borrowing and higher interest rates pose a significant challenge to China's corporate borrowers, especially the SMEs. With China's large and still-expanding contribution to global corporate debt, the higher financial risk is causing overall corporate risk to increase globally. As the world's second largest national economy, any significant reverse for China's corporate sector could quickly spread to other countries.
Will we see more bond issuance in Asian capital markets?
Asian corporate borrowers remain dependent on the banking system, where lending practices are to an extent still made based on relationships. Consequently, we expect only a small gain in the share of capital markets by 2018. Even so, given the large debt-funding task and ongoing regulatory reform restraining bank lending in many areas, we expect the trend of global financial disintermediation toward debt securities to continue in the next few years.
In Asia-Pacific, we expect a steady increase in disintermediation in fast-growing economies such as China, India, and Indonesia, unless there are fresh capital injections into their banking systems. In China, the government seems more inclined to let government-related entities tap the debt markets, which could help deepen their capital markets. The share of debt securities in China has grown over the past five years although still at a low level. The growth of shadow banking in China suggests the disintermediation away from formal banking is higher than the percentage share of debt securities would indicate.
In Japan, unless Abenomics is more successful, the drift in share of debt securities could continue as bonds are allowed to mature without necessarily being refinanced. In the rest of Asia, while there is a longer-term trend toward developing local bond markets, those in the region are generally still small relative to the economies they are serving.
Terry Chan, the author of this article, is head of corporate research for Standard & Poor’s Ratings Services in Asia-Pacific.