Will Shandong debt default trigger debt crisis in China？ Will Regulations on Property Hurt Commodity? SMM Reports

SHANGHAI, Apr. 4 (SMM) - Recently, a number of companies in Shandong, including large ones defaulted. Shandong Tansins Group Co., which used to be one of China’s top 500 companies fell into a quagmire, with 7 affiliated companies entering bankruptcy reorganization. China Huishan Dairy Holdings is still subject to debt crisis. Besides, foreign institutions issued short selling report and claimed suspected financial fraud against Weiqiao Textile Company and China Hongqiao Group. So, the two companies delayed annual report audit and reported slump in stock prices and trading suspension. The consequence will be very serious if the issue is not properly resolved, the companies said.

Shandong debt problems raised market concerns. Will this trigger debt crisis across China?

Bloomberg economist Chen Shiyuan said: "In addition to the debt problem in Shandong Province, many companies in other provinces also incurred bond default recently. The proportion of debt accounted for nearly 250% of China's GDP, which was only 160% before the financial crisis, according to the Bloomberg industry research estimates. Continuously rising leverage ratio increased corporate interest rate expense, and also pushed up financial risk. Government infrastructure investment and real estate reflected economic stabilization recently, but the manufacturing is still sluggish. Tightening interest rate policy by the People’s Bank of China (PBOC) also makes corporate financial constraints worse, which is a reflection of crowding-out effect by the property market. The debt problem again reminded us of great downward pressure of economy. The government needs to help enterprises through macroeconomic policies. Meanwhile, the zombie companies which have lost the core competitiveness need to exit the market as soon as possible. As to this, the principle is to maximize the market mechanism effect."

Dunhe Fund Management Co.’s Macro Strategy Director Xu Xiaoqing said: “Shandong’s GDP ranked third in China, following Guangdong and Jiangsu, and before Zhejiang, accounting for about 9% of the national total. The economic volume is indeed great, but the economic structure of Shandong is still industrial-based, and showed a significant trend of heavy industrialization. Compared with other developed provinces, Shandong’s high-tech industry only represents a small proportion in the secondary industry structure, which is much lower than Guangdong, Jiangsu and Zhejiang.

The companies reporting debt default in Shandong are mainly from nonferrous metals and steel industries, which are with overcapacity. This is a result of economic structure adjustment by Chinese government, which is determined to eliminate outdated capacity. And this is similar to debt default at many companies in Liaoning Province last year. In contrast, banks' non-performing rate in Guangdong and Zhejiang began to fall thanks to successful economic transition.

In fact, many companies had the risk of default in debt in April last year, including both private and medium and large state-owned ones, such as Sinosteel and Dongbei Special Steel Group Co. The market had worried about large scale of debt crisis.

Compared with a year ago, companies' profitability has significantly increased, with operating cash flow also greatly improving. This means a lower likelihood of debt crisis on the macro side. The proportion of balance of medium and long-term loans for industrials has been falling over recent years. The growth of loans in the heavy industry has been lower than other industries from 2013, and fell last year.

The rise in default rates is often a lagging indicator of the debt crisis, rather than leading indicators. After the outbreak of subprime crisis in the US in 2007, default rate of US loans and high-yield debt topped 10% in 2009, almost a record high. But the earnings of listed companies rebounded that year, and the stock entered a bull market. "

PBOC President Zhou Xiaochuan said the loosening period of China’s monetary policy has come to an end. So the bank is expected to tighten monetary policy. Will the property market cool down after the release of a string of regulations and in turn drag down economy？How will these macro-big changes affect the commodity market?

Xu Xiaoqing expects tightening liquidity and real estate regulations are the major reasons for the market to worry about the return of industrial products to the bear market. Similar macro environment also appeared in 2013. Purchase restrictions in the real estate market combined with cash crunch caused declines in industry products prices in the following three years. But the current macro conditions are very different from that time, so industry products prices did not see tendency decline but a wide fluctuation.

Monetary policy does not have the basis for continuous tightening. China’s CPI broke through 3% year-on-year in 2013, with M2 growth significantly higher than the target value. This is why the PBOC tightened monetary policy significantly. The CPI is now below 2%, and M2 growth rate is lower than M2 target value. The tightening of monetary policy is not for the real economy, but to drive capital to real economy. So despite uplift of interbank repurchase rate, growth of informal financing did not see a sharp decline. The continuous decline in informal financing during 2013-2015 precipitated a collapse of investment demand.

Besides, real estate stocks are at a very low level. Real estate inventories were at a record high in 2013. As long as sales fall, real estate investment will be hurt immediately.

Residential inventories in the third and fourth-tier cities fell to 2011’s levels, and those in the first and second-tier cities will be sold out in 2-3 quarters. Given such low inventories, developers will need to replenish stocks even if sales report much slower growth this year. As such, growth in housing starts may be unlikely lower than last year.

The concentration ratio of overcapacity industries has increased. In 2013, the manufacturing sector was at the peak of capacity expansion. Producers went on producing despite losses. With the bankruptcy of some enterprises and the continued decline in manufacturing investment in the past few years, capacity utilization has increased. Liquidity pressure of leading enterprises also alleviated significantly. When coupled with the supply-side reform, producers will cut output if industry product prices continue falling.

Improving external demand has supported global commodity prices. In 2013, European economy began to weaken after the outbreak of the debt crisis, and emerging markets also faced capital outflows because of a stronger US dollar. China reported drop in exports. But now industrial prices fell, increasing export competitiveness. For instance, hot-rolled coil prices slumped previously with domestic softening car consumption. However, as domestic prices have been lower than abroad, exports began to improve.

For news cooperation, please contact us by email: sallyzhang@smm.cn or service.en@smm.cn.