China’s increasing appetite for debt poses a significant threat to the global economy, as the creditworthiness of its borrowers deteriorates and it surpasses the United States in having the largest group of corporate borrowers in the world, according to Standard & Poor's.
S&P also highlighted the growing role of the private debt market in China, as companies globally increasingly turn towards the debt markets to raise financing, and away from banks.
In the report, 'Credit Shift: As global corporate borrowers seek $60 trillion, Asia-Pacific debt will overtake US and Europe combined', S&P said corporate borrowers globally are expected to seek up to $60 trillion in new debt and refinancing through 2018, an increase on an estimated $53 trillion last year.
China now has more outstanding corporate debt than any other country, having overtaken the US last year, a year sooner than S&P expected. It had $14.2 trillion outstanding at the end of 2013, compared to the US' $13.1 trillion.
Jayan Dhru, global head of corporate ratings at S&P, said: “The emergence of China as the biggest group of corporate borrowers, moderately increasing bank disintermediation, and faster debt growth in sectors related to the growing global middle class are likely to drive global corporate debt issuance over the next four years.
“The US continues on the path to economic recovery while the Eurozone struggles with marginal growth, but the bottom line is that this is a China story. Higher risk for China's borrowers means higher risk for the world,” he added.
S&P compared China’s corporate borrowers to more than 8,500 listed global peers to arrive at its conclusion, finding that while the country’s corporate companies started 2009 better off than their global peers, cash flow and leverage have worsened in subsequent years.
This “will lead to an overall increase in risk, since the credit quality of corporate borrowers in Asia-Pacific is generally lower than in North America and Europe. Consequently, without improved risk assessment among investors and a heightened awareness by regulators of contagion risk, some future financial stress could stem from Asia,” the report said.
At present, China’s corporate issuers account for about 30 percent of global corporate debt. Between a quarter and a third of this is backed by China’s so-called 'shadow banking' sector, meaning that at least 10 percent of the world’s corporate debt, around $4 trillion to $5 trillion, is provided by private lenders.
“With China’s economy likely to grow at a nominal 10 percent per year over the next five years, this amount can only increase,” the report stated, adding, “Given the substantial share that shadow banking contributes in financing not just China's corporate borrowers but also local and regional government financing vehicles, a sharp contraction would be detrimental for business generally,” and “could spread to spread to other countries.”
In a related report, titled 'Global bank disintermediation continues as corporate borrower needs outpace banks' capacity,' S&P predicted non-bank lending activity would grow 3.5 percent or nearly $3.1 trillion by 2018, as a result of ongoing regulatory reform restraining bank lending.
This will “likely be filled by bond investors and other non-bank lenders,” S&P said. Banks will intermediate 52 percent of corporate debt by 2018 compared with 55 percent in 2013, it found.
However, bank disintermediation will occur at different rates in different regions, it said. Fast growing economies like China and Brazil, which still rely heavily on their banking systems for funding, may experience it more rapidly than mature markets unless they receive fresh capital injections into the banking systems, S&P said.
In Europe, growth in disintermediation is expected to be more moderate amid sluggish growth, with the exception of the UK. “The UK could experience a steady increase in disintermediation because of banks' reduced lending capacity and an increase in corporate financing needs,” the report said.
The bond markets in particular will make significant headway in the Eurozone and the UK, according to S&P’s 2018 projections. It also forecasts rises in the US.
“In Europe, the equity challenge facing eurozone banks, the low absolute (and relative to floating rate) capital markets funding costs, and the desire to diversify funding sources convince us that the bond markets in Europe (eurozone and UK) will continue to grow their market share of outstanding debt through 2018,” S&P said.