Circumstances aren’t moving in China’s favour. The nation’s companies rushed to borrow in dollars when there was a 3 per cent to 5 per cent spread between Chinese and US interest rates and the yuan was expected to strengthen. Borrowing offshore was cheaper and offered the additional bonus of likely currency gains. Now, the spread in official short-term yields has shrunk to near zero and the yuan has been depreciating for most of the past year. Refinancing debt in dollars has become harder, and more risky.
China faces funding pressure
Beijing’s policies have exacerbated the buildup of foreign debt. To promote Xi Jinping’s Belt and Road Initiative, the president’s landmark foreign policy endeavour, China has been borrowing dollars on international markets and lending around the world for everything from Kenyan railways to Pakistani business parks.
With this year and 2020 being the peak years for repayments, China faces dollar funding pressure. To repay their dollar debts, Chinese companies will either have to draw from the central bank’s foreign-exchange reserves (a prospect Beijing is unlikely to allow) or buy dollars on international markets.
This creates a new set of problems. There are only 617 billion yuan ($127 trillion) of offshore renminbi deposits in Hong Kong available to buy dollars.
If China were to push companies to bring debt back onshore, this would necessitate significant outflows that would push down the yuan’s value against the dollar.
International dollar investors need to be wary of Chinese-linked investments.
Local government financing vehicles and belt-and-road borrowers may seem quasi-sovereign quality, but any shift in the willingness to roll over dollar debt could create a funding crunch. With the US Federal Reserve raising rates and reducing its balance sheet, Chinese companies could face paying more for capital in dollars than in yuan.
Bulls have long argued that China’s financial risks are contained because of the country’s low levels of external debt and large foreign-exchange reserves.
That has changed. China’s external debt has been increasing by an average of $US70 billion per quarter since the beginning of 2017. If it keeps rising, Beijing will have the unpalatable choice of burning through its reserves or letting the yuan fall, both of which would carry additional risks.
China and the world need to think clearly about this growing dollar debt dependence. Any cessation of funding could have severe and unforeseen consequences.
Bloomberg
from A Viral Update http://bit.ly/2LQH2cP
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