China’s economy is a subject of frenetic debate among economists right now — the country’s growth is slowing and the stock market’s summer collapse caught headlines.
Analysts are divided over just how bad the slowdown in the country’s growth could be — some say economic expansion could fall as low as 3%, while others say the current 7% trend might be sustainable in the long run.
But one sector is looking particularly awful, whatever angle you look at it from.
Analysts at Australian investment bank Macquarie have been digging into the figures on China’s debt profile, and what they have found is astonishing, particularly for the mining, smelting, and materials sector — the companies most exposed to the commodity price slump.
The level of debt in these sectors is so high that firms are under “extreme strains to survive” according to the research.
The graphs below measure the amount of debt interest costs that is covered by EBIT (earnings before interest and tax). So a company over that 100% line has its entire earnings (and more) absorbed simply by servicing the interest on its debt — an extremely financially precarious position to be in.
Here’s how it looked in 2007:
It’s clear to see that very few of the companies are in a particularly worrying position. Just four firms, which together held relatively little of the sector’s total outstanding debt, were above to 100% line.
The vast majority of companies wer below the 50% mark, and about half of the cumulative debt was held by companies below the 25% level.
Now, fast-forward to 2014:
The chart is practically unrecognisable. Half of the companies are now above the 100% line, and much of the upper end stretches above the 200% line.
Just about a tenth of the companies come in below the 50% line and barely any at all come below the 25% line. In short, the sector’s debt burden is immensely larger than it was eight years ago.
What’s more, check out the horizontal axis. The total cumulative debt in 2007 sat below 1 trillion yuan ($US136.8 billion in 2007).
Now, it’s running at over 4.2 trillion yuan ($US674.3 billion in 2014).
So there’s been a more than 300% increase in corporate debt for the 111 companies referenced, and earnings at those companies haven’t increased at anything like the same pace.
These figures might not matter so much anymore, but for the fact that there’s neither been an improvement in China’s growth prospects nor in commodity prices since then — the growth outlook has dwindled lower, and prices have continued to plunge:
Economist Michael Pettis argues that the two issues — heavy debts and a lack of growth — are self-reinforcing:
Debt was already a problem in the Chinese growth model more than ten years ago (and is a problem in several advanced economies too, who are going to find it nearly impossible to grow out of their debt burdens without implicit or explicit debt forgiveness).
Those analysts who do not understand why this is the case probably do not understand why the balance sheet will continue to be a heavy constraint on Chinese growth and will underestimate the difficulty of the challenge facing Xi Jinping and his administration, which means among other things that they will be too quick to criticise Beijing for failed policies when growth drops below their projections.
Whatever the prospects are for China’s economy, the level of debt that the country, and particularly the mining and materials sectors, have accumulated is astonishing, and any company with a connection to commodities is being hammered on two sides.