Thursday, March 6, 2014

China's credit markets under pressure

China's corporate sector has been hit with escalating credit problems. Here is the latest:

1. Shanghai Chaori Energy Science and Technology is about to miss a coupon payment on its bond (see story).

2. As a result, Suining Chuanzhong Economic Technology Development and 2 other companies scrapped their bond offerings - demand for new issue corporate bonds has dried up.

3. Secondary corporate bond trading has also slowed materially. This is fairly new for China since it has never really experienced large scale credit problems in its nascent bond markets.

4. There are indications that banks are cutting back lending as a result. In particular lines have been cut to natural resource wholesalers, traders, and importers (iron ore, steel, cement, etc.). These borrowers in turn are forced to sell inventory that is ofren used as collateral for these loans. Inventory sales depress prices of some of the raw materials, generating further losses for these businesses. This is compounded by the nation's slack industrial demand, with steel mills now running at 50-70% of capacity.
Iron ore April futures contract (source: barchart).

5. With banks cutting back on lending, demand for interbank funding fell materially, sharply lowering China's money market rates. Both 7-day repo and the 1-week SHIBOR are at lows not seen in quite some time. While lower money market rates are good for banks, at this point there is ample liquidity in the system with far less demand.

7-day repo rate (source: chinamoney)
1 week SHIBOR

These developments are quite negative for China's economy. Confidence in the nation's credit markets - both bank lending and corporate bonds - has taken a hit. It remains unclear however just how pervasive these problems could become - some think this is just the tip of the iceberg (see story).
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