Debt Crisis in China?

Yi HuangAssistant Professor of Economics

Pictet Chair in Finance and DevelopmentThe Graduate Institute, Geneva

EUInomics workshop, European University InstituteApril 29, 2016

Motivation: Growth slowdown and debt rising

Source: Buttiglione L, P Lane, L Reichlin and V Reinhart (2014)

Motivation: Financial Repression and Local Government Debt

Source: Yi Huang, Marco Pagano and Ugo Panizza (2015)

Motivation: Misallocation between State-Owned and private firms

Source: Jianjun Miao, Pengfei Wang and Yi Huang (2015)

Motivation: Retail Investors and Securities Margin Trading

Stock price and Securities Margin Trading

Source: Matthias Efing and Yi Huang (2016)

Chinese Story of Dollar Bond Issuance

I Global dollar liquidity and domestic financial conditionsare associated with the magnitude of carry, the yield frominterest rate differential adjusted for expectations ofRMB-Dollar exchange rate change.

I Profitable carry is an incentive for the dollar bond issuanceby “lemon” firms with international capital market access.

I Real and financial effects of dollar bond issuances: sizableUS dollar-denominated borrowing without hedging andfinancial intermediation (lending) activities.

Stylized fact

Chinese Firms Bond Outstanding by Currency

Source: Richard Portes and Yi Huang (2016)

Stylized fact

Foreign Currency Bond Outstanding

I After 2009, due to the new regulation, Chinese enterprises have been forbidden frompurchasing any FX derivatives in order to maintain “financial stability” .

Bond Issuers: non- tradable sector,‘overcapacity” industries, “lemon’...

Top 10 Industries of Bond Issuance (billion USD)

Industry Total Amount Percentage

Construction/Building 575.52 17.78Utility & Energy 443.91 13.72Oil & Gas 354.32 10.95Real Estate/Property 331.05 10.23Transportation 322.24 9.96Mining 215.01 6.64Metal & Steel 199.98 6.18Holding Companies 178.51 5.52Computers & Electronics 109.95 3.40Chemicals 75.51 2.33

Over-capacity industries refer to Iron, Cement, Flat Glass, Aluminium,Ship-buildings, Construction/Building and Real Estate/Property.

USD Bond Issuers: non- tradable sector,‘overcapacity” industries,“lemon’...

Top 10 Industries of Dollar Bond Issuance (billion USD)

Industry Total Amount Percentage

Oil & Gas 158.77 36.42Real Estate/Property 97.22 22.30Computers & Electronics 70.17 16.10Utility & Energy 33.47 7.68Metal & Steel 13.80 3.17Transportation 12.83 2.94Construction/Building 11.70 2.68Chemicals 8.73 2.00Mining 5.19 1.19Food & Beverage 4.93 1.13

Over-capacity industries refer to Iron, Cement, Flat Glass, Aluminium,Ship-buildings, Construction/Building and Real Estate/Property.

Monetary Policy and Over-capacity Industries

USD bonds outstanding by industry

After 2009, according to the new/tight monetary policy, commercial banks inChina have been discouraged to lend to the “over-capacity” industries and theyconsequently issue dollar bonds abroad.

Outstanding USD Bond and FX Risk Exposure

USD Bond Outstanding and Exchange Rate

I After 2009, due to the new regulation, Chinese enterprises have been forbidden frompurchasing any FX derivatives in order to maintain “financial stability” .

Main Findings

I Using international bond issuance data from all Chinese non-financial firms, we find that by 2015 there was more than 475billion of US dollar dominated debt outstanding. Most of theoutstanding dollar debt without hedging.

I There is a positive correlation between inter-firm loans anddollar bond issuance, which indicates the role of financialintermediation between financial assets and liabilities predictedby Shin and Zhao(2013) and Bruno and Shin(2015).

I Firms with lower value, weaker performance, corporategovernance and no foreign cash flow tend to increase inter-firmlending when they issue dollar bonds- a form of financialintermediation.

I Private firms and over-capacity industries tend to increaseinter-firm lending when they issue dollar bonds.

Conclusion and Policy Implication

Firms in a financially repressed environment (such as China) useinternational bond issuances to raise funds....

....but this is a risky game. Chinese firms that issuing dollar bondswhich are characterised by lower value, weaker performance,corporate governance and without foreign exposure tend to have morefinancial intermediation activities.

They also tend to extend more (inter-firm) loans, sparking potentiallyinefficient credit growth and introducing financial fragilities.

Reconsider the real and financial effects of dollar bond issuances whileencouraging domestic financial market development.

Discussion

Thank Youyi.huang@graduateinstitute.ch