Corporate debt dynamics increase risk of hard landing for China’s economy

Recent efforts by the Chinese government to cushion its economic slowdown, partly sparked by the trade dispute with the US, by cutting taxes and easing monetary policy, are forcing corporate debt levels up again and will make it more difficult to avoid an economic hard landing in the medium term, according to trade credit insurer Atradius. The has insurer published a note entitled ‘Private debt could amplify costs of the trade war’, in which it says private sector debt developments in the US and China probably won’t trigger an economic crisis but could deepen a downturn, possibly triggered by the bilateral trade war. Atradius asks if the trade spat could prove to be "the straw that breaks the camel’s back". “The world economy’s expansion is on increasingly shaky ground, with risks stemming most significantly from its two largest economies. The US economy has now matched its longest period of consecutive growth on record but uncertainty is increasing, bringing the Fed back to a defensive position. China’s economic growth, while still robust in part thanks to government support, has slowed to its lowest rate since records began in 1992. What could be the trigger to knock either of these economies off course?” asks the insurer. It points out that private sector debt in the US was the key trigger of the global financial crisis in 2007 but thankfully, at this point it is not sufficient for a repeat. “The most glaring potential culprit now is the simmering trade war. While a truce barring further escalation of punitive tariffs was reached in June, the tariffs put in place thus far are estimated to cost the US 0.2% of GDP and China 0.5% (Oxford Economics). At this rate, that’s not enough to knock either country into recession, but an escalation could. And private sector (corporate and household) debt in both economies could likely amplify this,” explains Atradius. “Higher tariffs translate into lower earnings, raising corporate debt distress and resulting in more layoffs and less investment. That amplifies the economic downturn and increases credit risk. As the composition of private debt in both economies has deteriorated in recent years, access to funding is becoming increasingly expensive for the highly leveraged firms amid global uncertainty – even in spite of loosening monetary policy by both Beijing and Washington,” continues the insurer. China’s economy has been slowing down as a consequence of the transition from export- and investment-led growth to domestic, consumption-driven growth anyway. But Beijing’s financial deleveraging campaign and the US import tariffs also have their impact. Atradius explains that, to avoid a hard landing, the Chinese government cut taxes and eased monetary policy, which cushioned the downturn. But growth in the second quarter of this year still slowed to 6.2%, the slowest pace in almost three decades. Another negative effect of the policy has been to cause corporate debt to tick back up to record levels in the first quarter of this year. “This underlines the authorities’ limited room for manoeuvre to cushion the economic slowdown in the short term, as it increases longer-term risks to financial stability. As in the US, the high corporate debt and its deteriorating quality could amplify this downturn, making it harder to avoid a hard landing. Note that while profits at Chinese private firms grew 6.6% year on year in January-May 2019, those at SOEs [state-owned enterprises] fell 9.7%. Declining profits could make financing more difficult, raise debt distress, result in more layoffs and less investment, and could as such amplify the downturn,” concludes Atradius.

Corporate debt dynamics increase risk of hard landing for China’s economy

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