China: Measures to reduce corporate debt – Nomura

Research Team at Nomura, notes that recently the China’s State Council issued its Opinions On Proactively and Steadily Reducing the Corporate Sector's Leverage Ratio (called “the Opinions” hereinafter) which is a step towards preventing potential financial risks from high debt and deleveraging essentially means debt reorganization or default, in Nomura’s view.

Key Quotes

“We estimate non-financial sector debt stood at RMB158.5trn, or 231% of GDP, by end-2015, mostly owed by the corporate sector (150% of GDP, if excluding debt of local government financing vehicles (LGFV)).

We provide the following takeaways from the Opinions:

• The government is encouraging mergers and acquisitions (M&A) as a means of opening the door to private capital and encouraging the exit of “zombie enterprises”. We therefore look forward to more M&A activity among state-owned and private capital, and expect more defaults and even bankruptcies further down the road.
• The government suggests optimising debt structures in the corporate sector through increasing the share of direct financing (such as equity) and improving financing efficiency.
• More details on the “debt-to-equity swaps” were published. According to the Opinions on market-oriented debt-to-equity swaps, debt here refers mainly to bank loans, and it should be transferred to other agencies (such as asset management companies, insurance asset management companies, and state capital investment/operation companies) before it is swapped into equity. The swaps should be market-determined and the government has no obligation to provide a backstop.

Overall, the measures suggested by the Opinions to resolve the high corporate debt problem are largely in line with our view. They are mostly associated with reforms to reorganise corporate debt via innovative ways such as debt-to-equity swaps. A rising default rate is inevitable, and we also believe there will a further shift of debt from the corporate sector to the government.”