China is caught between a debt rock and a hard soaring dollar.
On one hand, over the past few years, taking advantage of a relatively cheap and stable dollar, China's semi-SOEs corporations gorged themselves on dollar borrowings, blowing out their balance sheets but not in yuan but rather in greenbacks. On the other hand, the dollar has surged in 2018 as the yuan has tumbled at a pace not seen since the 2015 devaluation, leaving USD-exposed borrowers scrambling to rollover existing debt.
So faced with the threat of another surge in defaults among USD-borrowers, Bloomberg reports that China is slowing approvals for offshore bonds and is even considering whether to ban outright short-dated issuance in dollars, moves that would reduce financing options for the debt-laden developers that sit at the center of the nation’s economy.
The National Development & Reform Commission is weighing a ban on the sale of dollar bonds with tenors of less than one year, said the people, who asked not to be named because they’re not authorized to speak publicly. The regulator is already restricting offshore issuance quotas for Chinese companies, people said.
In the regulator’s statement, it said that the use of proceeds from builders’ overseas bond sales must be limited to just refinancing, instead of investing in domestic property projects and replenishing working capital.
“Some of the issuers have low profits, which don’t match the amount of foreign debt they are raising,” the NDRC said, referring to developers and to local government financing vehicles.
The news was the latest hit to Chinese stocks, with property developers and airlines tumbling overnight: Air China has fallen for 11 straight days in Hong Kong, its longest ever losing streak. China Southern Airlines has plunged 35% in 10 days, while developer Country Garden Holdings is the worst performer on the Hang Seng Index this week.
There was a similar rout in the bond market, where most Chinese property dollar bonds fell, with China Evergrande Group and Logan Property Holdings leading the losses. In the past two years, Chinese developers have sold about $10 billion of dollar notes that mature in less than a year, Bloomberg-compiled data show.
“The news that China will crack down on property speculation in 30 cities hurt sentiment and put pressure on shares,” said Dai Ming, Shanghai-based fund manager with Hengsheng Asset Management Co. “It makes investors agitated whenever China tightens regulation over the property sector.”
Why the focus on short-term debt? Recently, selling bonds that mature in 364 days had become a popular financing tactic because as Bloomberg notes, it didn’t require pre-approval from the NDRC.
The regulator has publicly signaled that it’s wary of the offshore issuance boom, saying in a Wednesday statement that developers are only allowed to use proceeds to refinance existing debt, that some companies are borrowing amounts that are out of proportion with their profits, and that many don’t have foreign-currency revenues to protect themselves against the yuan’s slide.
Commenting on the decision, Scott Bennett, Hong Kong-based executive director of fixed income at Oppenheimer Asia said that “I find this an understandable move, however issuers will unlikely be happy. It could be negative in the short-term for weaker Chinese property developers as this removes one source of refinancing and may potentially lead to defaults."
While the move is the latest attempt by China to rein in runaway leverage, and is expected to be good for the market over a longer term as it’ll filter out riskier issuers, CITIC CLSA Securities analysts wrote that “turmoil awaits" as companies with near-term debt maturities scramble to make ends meet.
Chinese builders who splurged on dollar issuance in recent years are facing bond repayments of $77.4 billion in the domestic and overseas markets through 2019, and have been reeling from tightened liquidity at home induced by a clampdown on shadow financing. That’s prompted them to sell debt in the offshore market, with dollar bond sales reaching a record $27.5 billion this year. The latest regulatory intervention would limit their use of that offshore funding venue; it would also shield issuers from an increase in debt-servicing costs if the yuan keeps falling.
It was not immediately clear where they would find alternative funding at yields that do not put them on a precarious path to mass defaults, something which China has already been hit by in 2018, something we described in "Is It Time To Start Worrying About China's Debt Default Avalanche"
The silver lining is that the latest developments are positive for the medium term stability of the industry, according to Charles Macgregor, head of Asia markets at Lucror Analytics in Singapore. "We do not see this as a likely stimulus for defaults – that is not in the interests of the NDRC."
“My view would be that that is just to limit the currency risks that exist. We’ve seen many periods of history that it’s dangerous to borrow too much in a foreign currency because not only do you have interest rate costs but also FX risks,” said Nicholas Wall, London-based fixed income portfolio manager at Old Mutual Global Investors in Hong Kong. Dollar appreciation “could increase risks for sectors that are tremendously important for China and Chinese growth,” he said.
While the long-term view is accurate, and is a much needed "rationalization" of China's bloated corporate debt bubble, the bigger threat is if the bond market "turmoil" gets out of control at a time when China's economy is already suffering; meanwhile should the sharp Yuan devaluation not serve as a boost to the economy but merely reinforce the same capital outflow dynamics observed in late 2015 and early 2016, it is likely that a repeat of the global bear market that ensued over two year ago - from which the US was mostly spared - could be in the cards.