Within the past few months, the Chinese government has announced a number of broad economic reforms. The movement toward a more open economy is good news for foreign firms, but it also creates risks. "In the near term, potential negative impacts on the real economy as a result of the reform effort and credit risks associated with the rising cost of funds have to be watched out for," says Rocky Tung, Asia Pacific economist with credit insurer Coface.
Coface recently released a report describing those risks in detail. It predicts that although Chinese leaders are hoping consumer spending will take over as the nation's primary driver of economic growth, business investment will retain that position through 2014. For that reason, the rising interest rates Coface expects to see may have a significant effect on the health of the economy.
Borrowing in China has become more market-driven since the government's announcement of a lending-rate liberalization plan last July. Expectations that liquidity will tighten in the near future are putting pressure on China's local bond and money markets. And the Shanghai Interbank Overnight Rate (SHIBOR) one-week and one-month rates both rose sharply in December. "Interest rate volatility could be higher in 2014," Tung says. "The SHIBOR hike in December is indicative of the central bank's intention to reduce the pace of balance sheet expansion going forward. Businesses should manage their credit wisely; the size and number of claims [Coface is] experiencing have alerted us that credit risk in China is on the rise."
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Figure 1, below, shows trends in the weighted-average lending rate for general loans in China, which represents interest rates for general-purpose business and individual loans, weighted to account for the sizes of the loans. It also shows the weighted-average lending rate for all lending, which includes general loans, trade finance, and more.
Coface expects China's macroeconomic growth to remain stable in 2014 (see Figure 2). "Reforms are the key focus for the country in 2014," Tung says, "while counter-cyclical measures will be adopted to maintain growth at 7 to 8 percent."
In this environment, borrowing will become more challenging for many companies. "With stable money supply growth, overall liquidity could become even tighter in 2014," Tung says. Many local and provincial projects started in China in 2009 to 2010 were financed with bonds and trust loans with three- to five-year maturities. "These repayment obligations will further tighten liquidity in the market," Tung adds. "Development in this area has to be watched out for in 2014."
To gauge the microeconomic effects of these trends, the Coface report analyzes several different industries. In general, the insurer expects that "certain industry participants will start facing climbing pressures," Tung says. "Highlighted by the government's advocated effort to tackle overcapacity issues, smaller and inefficient participants in 'oversupplied' industries will be facing pressure, from rising costs to policy uncertainties."
Certain subsectors of the electronics industry, in particular, are already seeing deteriorating payments and are likely to have a challenging year. Nevertheless, the outlook is positive for many Chinese companies. Tung predicts that small to midsize businesses will start to have an easier time borrowing from banks.
"With interest rate reform and RMB [renminbi] internationalization on the agenda, financial reform is at the heart of China's reform roadmap," he says. "Combine that with the strong push toward a market-based economy, [and] these reforms could bring in competitiveness to the various industries in the long run.
"They will also create near-term turbulence, particularly to the giants in various industries in China," Tung concludes. "Increasing competition, as well as the rising cost of capital, are expected to bring negative impact to the traditionally dominating enterprises in the various industries within China." For foreign firms that tread carefully, however, opportunities abound.
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