Chinese credit crunch

The recent default of Chaori Solar (on a corporate bond coupon payment) and the apparent default of property developer Zhejiang Xingrun Real Estate (on bank debt) have so far been relatively modest This partly reflects that lower quality corporates have already been re-priced substantially since mid-2013 to reflect the higher probability of default. However, the five-year corporate-government yield spread is currently more than 1,000bp for BBB+ corporate debt, which emphasises that lower quality corporate debt is currently facing extremely difficult refinancing conditions. With the government acknowledging that defaults are a necessary part of China’s longer-term structural adjustment, China will face corporate defaults. The main question is to what extent it will turn into a systemic risk for the financial sector

So far, the interbank market has moved out of the stress that characterised it in December and late January. Interbank rates have plunged recently and short-term money markets rates are below 3%. Government bond yields and swap rates have declined with the swap-government bond spread also easing a bit recently, though the spread remains somewhat elevated. Based on the development in interbank rates and government bond yields, it appears the Peoples Bank of China (PBOC) has effectively already started easing and that a large part of the de facto monetary tightening in H2 13 has now been removed. Liquidity in the interbank currently appears to be well supported by the PBOC’s recent purchases of USD. The next hurdle for the interbank market will be end-June time, when liquidity demand usually spikes.

Credit flows overall remain weak with particularly shadow finance loans slowing markedly since mid-2013, although this is to some degree being offset by stronger loans from banks. However, M2 money supply growth has stopped declining and in February, improved slightly in real terms. Leading financial indicators such as money M2 supply growth and interest rates levels suggest that the Chinese economy will continue to deteriorate for another four to five months but will start to stabilise in Q3.