Residential buildings under construction at the Phoenix Palace project developed by Country Garden Holdings Co. in Heyuan, Guangdong Province, China, September 2023.
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BEIJING — China’s state-run economy could be setting the stage for a new wave of bond defaults that could occur as early as next year, according to a report from S&P Global Ratings released Tuesday.
The rating agency noted that this would be the third round of corporate defaults in about a decade.
It comes amid extremely low default rates in China amid concerns about overall growth in the world’s second-largest economy.
“The real question for policymakers to look at is whether the current guidelines are creating distorted incentives in the economy,” Charles Chang, S&P Global Ratings’ head of China, said in a telephone interview Wednesday.
China’s corporate bond default rate fell to 0.2% in 2023, the lowest in at least 8 years and well below the global rate of about 2.6%, according to S&P.
“To a certain extent, this is not a good sign because we view this divergence as something that is not a result of the functioning of markets,” Chang said. “In the past year, we have seen government directives or recommendations to prevent defaults in the bond market.”
“The question is when will there be guidelines to prevent defaults in the bond market. [ends]What’s happening to the bond market? he said, noting that this is something to keep an eye on next year.
Chinese authorities have emphasized the need to prevent financial risks in recent years.
But tough approaches to problem solving, especially in the real estate sector, can have unintended consequences.
The real estate market has slumped since Beijing cracked down on developers’ high reliance on debt over the past three years. The once huge sector has dragged the economy down, while the real estate sector shows little sign of improving.
Real estate led the latest wave of defaults between 2020 and 2024, according to S&P. Prior to this, their analysis showed that industrial and resource companies were the leaders in defaults in 2015–2019.
“The bigger question for the government is whether the property market can stabilize and property prices stabilize,” Chang said. “This could potentially mitigate some of the negative welfare impacts that we have seen since the middle of last year.”
Most household wealth in China is concentrated in real estate rather than other financial assets such as stocks.
Problems of economic growth
Bond defaults fell in most sectors last year except technology services, consumer discretionary and retail, according to S&P.
“This points to the potential vulnerability of the slowdown we are seeing now,” Chang said.
China’s economy grew 5.2% last year and Beijing has set a GDP growth target of around 5% for 2024. Analyst forecasts are generally close to or below these rates, with further double-digit slowdowns expected in the coming years. growth of past decades.
China’s large levels of public, private and hidden debt have long raised concerns about potential systemic financial risks.
But China’s debt problems are not as pressing as Beijing’s need to address real estate issues as part of a broader “comprehensive strategy,” Vitor Gaspar, director of financial affairs at the International Monetary Fund, said at the conference. press briefing last week.
He said other aspects of the strategy include China’s emphasis on innovation and productivity growth, and the need to strengthen social safety nets to make households more willing to spend money.
It remains to be seen whether other sectors will be able to offset the real estate sector’s impact on the economy and support overall growth.
UBS on Tuesday upgraded its MSCI China stock rating to outperform due to improved corporate earnings, which are unaffected by property market trends.
“The largest stocks in the China index generally performed well on earnings and fundamentals. Thus, China’s underperformance is solely due to valuation collapse,” Sunil Thirumalai, chief GEM equity strategist at UBS, said in a note. “What makes us more positive about earnings is the early signs of a pickup in consumption.”
The bank also improved its forecast for Hong Kong stocks.
Speaking on why UBS changed its view on China’s valuations, Thirumalai noted the “increasing tendency of Chinese companies to deliver positive dividend/share buyback surprises.”
“Such higher visibility into shareholder returns could be useful if global markets become more concerned about geopolitics, as well as in scenarios where the higher level is more long-term. We will monitor the next stage of market reforms,” he added.