Overview
- Debt ballooned in China on the back of the decade-long property boom. This has become an issue as the housing market declines.
- While China’s headline debt-to-GDP is high at over 300 per cent, a good chunk of that falls on entities tied to local governments. The central government has room to borrow and support growth.
- Sectors such as financials are filling the gap left by property developers in the offshore high yield bond market, while emerging markets beyond China offer diversification for debt investors.
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China's choices
Debt finds itself in the spotlight when an economy slows. Governments want to borrow to boost growth and markets want to know if they can pay it back.
At first glance, China’s 300 per cent debt-to-GDP ratio looks high. But once you take away layers of debt tied to local governments and focus on the central government’s balance sheet, “then the 300 per cent becomes about 40 per cent, which is quite low and similar to other A-rated sovereign debt levels,” says Bich Nguyen, director of research for fixed income, Asia Pacific.
The real constraint for China comes from its strategic intentions. Policymakers have been trying to move the economy away from the debt-fuelled growth of the past decade, centred around property and infrastructure, to a new model powered by consumption and innovation. “A higher-quality approach will take longer to achieve, but the fact that the government isn’t relying on China’s traditionally credit-driven expansionary model is a critical sign that it is prioritising financial stability,” Bich added.
Housing headaches
At the heart of China’s debt conundrum - and its economic miracle - is the rise of the property market over the last two decades. Home prices raced higher along with GDP growth after China’s entry into the World Trade Organisation in 2001. “Along with that came the expansion of [a] middle-income class, whose aspiration to own homes grew naturally,” says Hong Kong-based portfolio manager Tae Ho Ryu, who specialises in Asian high yield bonds.
Equally important are local governments. Their revenue streams have been dominated by land sales, which have weakened due to the housing slowdown. Markets have since become worried about their shadow financing, aided by local government financing vehicles (LGFVs). But not all LGFVs are the same, and those backed by wealthier localities could be attractive to bond investors. “Shanghai and Jiangsu province are definitely different from [inland provinces] Xinjiang or Henan,” said Olivia He, a Shanghai-based portfolio manager.
Unlike the 2008 US subprime crisis, China’s housing headaches have not spilt over into the banking system. “There was less reliance on complex instruments to drive property growth, a lot of which was organic,” Bich explains. “The similarity with the US centres around leverage.” The difference is that a lot of the banking sector is state-owned in China, and the government has stepped in to stop the housing bubble from getting out of hand - possibly because they’ve seen the alternative play out in the US.
New hope
In fact, the steady performance of Chinese banks and other financial institutions means they are now seen as relatively safe bets in Asian markets. Financials have helped fill the void left by property developers, and now account for a quarter of offshore Chinese high yield bonds. “We recognise investors’ concerns about the property crisis spilling over into the banks and the financial system. But we have not seen any evidence of this materialising, and earnings have been mostly steady,” says Tae Ho.
Another aftermath of the Chinese property shakeup is that high yield investors are increasingly receptive to diversification within Asia. Popular destinations include India, Indonesia, and the Philippines, all of which are emerging economies with decent long-term growth prospects. Shifting supply chains, something discussed in the previous episode of this podcast, are also bringing markets such Vietnam and Mexico onto the radar for investors.
