Since our last estimate in 2013, China’s bad debt has surged. CLSA estimates the NPL ratio to be 15-19% above the official ratio of 1.6%. The NPL will worsen with the slowing economy but the government does not have a comprehensive NPL strategy. This is also showing up in bond defaults. Most of the bad debts are incurred by lossmaking companies.
We used bottom-up cash flow and debt-service-requirement analyses of listed A-shares and NBS industry data, consistent with IMF methodology. The official NPL ratio is much lower at 1.6%, as it reflects the implicit guarantees of SOEs and continuous rollover of debt.
In the unlikely scenario that all NPLs were recognised at once, a 15-20% NPL ratio would require Rmb6.8tn to Rmb10.6tn (10-15% of GDP) in fundraising, assuming 100% provisioning. NPLs will worsen with the slowing economy, but the government does not have a comprehensive plan. A full plan is needed ahead of the deadline for IFRS 9 and Basel III in 2018.
Government is stimulating again
The property correction, NPLs and unemployment have pushed the government to pursue further stimulus. Industrial capacity utilisation is near GFC lows, implying that bad debts will get worse. But stimulus is becoming less effective, requiring four units of credit for each unit of growth. Debt/GDP will exceed 300% by 2020.
Shadow financing could see losses equal to 4% of GDP
Our analysis would not be complete without addressing shadow financing, which we estimate to be 59% of GDP. Shadow financing remains small compared to other countries and uses less leverage. It is still mostly banks circumventing regulations and lending off-balance sheet, but we continue to estimate bad debt of Rmb4.6tn or potential losses equal to 4% of GDP.
Cautious going into 2H16
We have been positive on the market since January due to low valuations and government stimulus, but are turning cautious as its effect fades.