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More Chinese companies could default on their debts issued in U.S. dollars, experts warn.
They say that the rising cost of borrowing and a weakening Chinese yuan could see more firms fail to meet upcoming payments, as an increasing number of bonds mature in the next few years.
Japanese bank Nomura said in a research note in early November that for the first 10 months of this year, defaults on Chinese offshore corporate dollar bonds — or OCDB — totaled $3.4 billion, compared with none last year. It expects more defaults to come over the next two years.
So far, there's little chance that increased pressure on offshore dollar repayment could trigger a broader crisis, but the situation should be closely monitored for spillover threats.
"I'm watchful over how these dollar debts will roll over in time," Tai Hui, chief market strategist for Asia Pacific at J.P. Morgan Asset Management in Hong Kong, told reporters Thursday.
Hui stressed that he currently sees no systemic risks, but noted that financial strains often begin in one area before spreading.
"I think the government needs to be very mindful of some of these potential links," he said, adding that the property sector should be foremost in mind.
In its report dated Nov. 7, Nomura estimated that outstanding dollar-denominated Chinese corporate debt stood at about $751 billion in the third quarter. That's more than double the amount at the end of 2015.
It projected that an average of $33.3 billion of Chinese corporate dollar bonds will mature each quarter from the fourth quarter of 2018 to the end of 2020, sharply higher than the estimated $11 billion that matured in the third quarter of this year.
Defaults in Chinese OCDBs are also increasing in the fourth quarter after falling in the previous quarter, Nomura added, citing data from Bloomberg and its own analysis in the report.
"We believe that despite a respite in the summer, OCDBs have again been under increasing pressure, against a backdrop of weakening domestic demand, rising credit defaults, a depreciating RMB and Fed rate hikes," Nomura said, using an abbreviation for the renminbi, another name for China's currency.
Chinese companies can issue debt in yuan, or they can raise funds in U.S. dollars or other foreign currencies. However, issuing bonds in foreign currencies could involve substantial currency risks if not properly hedged for changes in exchange rate movements.
With the yuan having fallen more than 6 percent against the greenback so far this year, Chinese companies earning in the local currency will find repaying debt in U.S. dollars much harder. Some analysts expect the yuan to weaken further.
While a weak yuan boosts the competitiveness of China's exports, it also makes it more expensive for Chinese firms importing raw materials.
China's economy grew 6.5 percent year-over-year in the third quarter this year, expanding at its weakest pace since the first quarter of 2009.
The country's rise to become the world's second-largest economy has been accompanied by a staggering run-up in debt, which is estimated at more than 250 percent of GDP.
Meanwhile, the U.S. economy has been robust, with a tight labor market, resulting in wage inflation and an unemployment rate that's at its lowest since December 1969.
To prevent overheating in the world's largest economy, the U.S. Federal Reserve has been lifting interest rates. But as interest rates rise, bond prices fall and yields on U.S. dollar-denominated debt increase.
Some Chinese companies are issuing new bonds to raise money to pay off current obligations.
Major property developer China Evergrande Group, for example, said in a filing to the Hong Kong stock exchange on Oct. 31 that it was issuing $1.8 billion in new notes at interest rates of as much as 13.75 percent, "primarily to refinance existing offshore indebtedness."
Nomura also said that declining demand for new bond issuance will make it harder for companies to raise funds, with property developers likely to have a particularly difficult time. This could lead to smaller capital inflows, which may add pressure to China's foreign exchange reserves and possibly weaken the yuan further.
At the same time, together with a tight domestic credit supply, there would be "eventually more downward pressure on the economy," it said.
J.P. Morgan's Hui said that over the next five years China's bond markets will experience more stress, which he said is a positive result of the growing maturity of the country's economy and the government allowing market forces to play a bigger role.
"So without investors taking on some of that responsibility themselves by going through the pain, you're not going to get accurate pricing on risks," he told CNBC.