Dec 18, 2020 08:00 PM

Year in Review: Finance in China in a Word — Deleveraging

Editor’s note: When 2020 started, the U.S. and China sighed with relief that the phase one trade deal had been inked, and they both hoped it would slow the decoupling of their economies. U.S. President Donald Trump was gearing up for his campaign to get four more years in the White House. No one could have guessed how history would quietly change course and how fast the coronavirus wave would engulf everyone on the planet.

The pandemic has changed everything. Global supply chains have broken apart inch by inch — airplanes have been left stranded, factories have been closed, restaurants and cinemas have shut down, and cross-border travel ground to a halt. The very foundation of modernization and globalization has been shaken. No one can escape.

The virus is still rampant. But global economies and societies are moving in different directions: some reached new heights after initial setbacks, while others are still struggling. Easy money continues to push up asset prices. The biggest migration in human history — the migration to digital space — has created new winners and losers on a massive scale. The coronavirus might be the tiniest black swan in human history, and the global tech giants could be seen as the largest grey rhino in the capital market. Together the two shaped our 2020, and perhaps it will be many years before we can fathom the full impact that they have had on our lives.

Caixin has selected 10 themes to reflect on this unusual year with you, our readers. It saddened us that the light went out for so many people we cherished: the millions of Covid-19 patients who died, Kobe Bryant, Diego Maradona, and frontline doctors such as Li Wenliang. But 2021 promises a new dawn.

The Chinese central bank is clearly worried about macro leverage.

After years of deleveraging and cleaning up the shadow banking system, China’s debt-to-GDP ratio fell in 2018 before edging up in 2019. But in the first three quarters of this year, the ratio rose by 27.4 percentage points to 272.8% from the end of last year, as the country stepped up credit support to mitigate the impact of the pandemic.

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Deleveraging is necessary, and the PBOC has been consistent in carrying it out. But it has also met enormous resistance. The most obvious is the most recent delay of full implementation for new asset-management rules, which now won’t take effect until the end of 2021. November’s Henan provincial state-owned enterprise default is also being watched closely to see if the implicit government guarantee will prevail again.

These headwinds are to be expected. Like others around the world, China’s economy suffered a significant downturn earlier this year. Regardless, the opening up of China’s financial markets to international players is steadily moving forward, with major steps this year including approval for joint-venture wealth management companies with controlling foreign shareholders.

These moves — clamping down on off-balance sheet lending for domestic banking institutions while welcoming foreign players to bring internationally recognized best practices — is like “closing a window but opening a door,” according to one top regulator.

China launched the deleveraging campaign in late 2015, starting with the real economy and progressing to the financial sector. Some of the deleveraging measures have gone into hiatus as the country grappled with Covid-19. However, there are signs that the government is likely to resume its deleveraging process as China’s economy stabilizes.

Real estate sector deleveraging

Since China’s real estate sector took approximately 40% of total financing in 2016, it’s the prime target for the deleveraging campaign. In fact, part of the build-up of debt in the property sector has been due to the government, as it has boosted economic growth by channeling funds to developers, allowing shadow bank financing in the sector and periodically removing home purchase restrictions.

But the situation changed once China begun to focus on sustainability. The central government has repeatedly emphasized that the country would adhere to the principle that “houses are for living in, not for speculation,” and pointed out “real estate market should not be used as short-term economic stimulus.” Other efforts made in the past few years include restrictions on onshore and offshore bond issuances, curbing financing via shadow banking activities, toughening oversight on bank lending, and introducing a new round of credit tightening measures known as “the three red lines“ in August 2020, to reduce risks to the financial system posed by overleveraged property firms.

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Developers Face New Debt Limits as Property Crackdown Continues

Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission (CBIRC), warned again of the property sector’s potential threat to China’s financial stability in a recently published article, calling the property sector is “the biggest gray rhino“ in terms of financial risks.

SOE deleveraging

China’s SOEs provide not just employment, but also the driving force behind heavy industry and infrastructure. But the bloated SOE sector is also a major contributor to low production efficiency and the buildup of enormous debt in China, as many moved to borrow from banks for business expansion rather than relying on innovation. The excessive ratio among SOEs could lead to systemic financial risks if it is not controlled.

At the 2017 National Financial Work Conference, President Xi Jinping stated that “financial stability is the basis of national stability, and SOE deleveraging was the top of the top priorities.” The Politburo meeting that held following the Conference reiterated the concerns about containing financial risks, and agreed that China will prioritize supply-side structural reform, enabling the market to play a more active role in letting money-losing and debt-laden companies known as “zombies” fail.

In September 2018, the State Council published a policy that aims to lower SOEs’ average debt-to-asset ratio by 2 percentage points from year-end 2017 to year-end 2020. The guidelines also noted that clearer boundaries between government and corporate debt need to be set, with local governments strictly banned from borrowing in the form of corporate debt.

But such deleveraging halted due to the Covid-19 outbreak, as governments expected SOEs, including Local Government Financing Vehicles (LGFV), to raise more debt to invest in infrastructure construction, in line with its stimulus policies. However, the string of recent SOE bond delinquencies signaled that Chinese authorities are refocusing on deleveraging, promising a renewed emphasis on financial discipline and a “zero tolerance” for misconduct.

The pace of SOE defaults rose significantly in 2020, with 10 state-owned issuers defaulting on a total of 54 billion yuan ($8.3 billion) in bonds, or 42% of total defaults. In the past five years, 25 SOEs defaulted on a total of 156.8 billion yuan in bonds, accounting for about a third of total defaults. Overall, there have been 166 bond defaults this year as of Dec. 9, totaling 148.3 billion yuan, already exceeding the year total for 2019.

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The new wave of defaults has also triggered a wider sell-off in corporate bonds and a wave of bond issue cancellations, particularly among firms in Yongcheng Coal and Electricity Holding Group’s home province of Henan. Four bond issuances worth 3.1 billion yuan were canceled in Henan, all by local SOEs after the Yongcheng Coal bond default. Nationwide, 100.4 billion yuan of corporate bond issuances were either canceled or delayed in November, jumping from 34.3 billion yuan the previous month and 28.1 billion yuan in the same period last year. This brought the credit bond net financing in negative territory for two consecutive weeks.

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Cover Story: How SOE Default Wave Shows End of State Bailouts

From regulators perspective, the defaults are to be welcomed and such discipline is sorely needed. And it is true that lack of immediate bailouts and a zero-tolerance attitude toward fraud are positive signals for the bond market’s development. But that’s not the same as the end of the implicit guarantee, as economist Houze Song has noted. “That foundation is built on bank lending, which is about five times larger than bonds as a source of local financing ... so long as the relationship between local governments and banks holds, a form of implicit guarantee will persist.”

Financial sector deleveraging

The SOEs’ deleveraging campaign started at the same time as the crackdown on shadow banking, which poses challenges to monetary policy regulation and has been subject to extensive regulation. It provides a funding source for companies with relatively weak credit profiles. Meanwhile, shadow banking sector also has a substantial portion of real estate and LGFV financing, but there are stricter macro level financing policy restrictions on both sectors as we mentioned in the previous section.

Since the first quarter of 2017, the central bank has rolled off-balance-sheet financing into broad credit indicators for its Macro Prudential Assessment (MPA) risk-tool, which supervises the financial institutions in terms of capital and leverage, assets and liabilities, liquidity, asset quality and is seen as an important policy tool in the deleveraging process.

Other regulations included peer-to-peer (P2P) lending rules that prohibited illegal fundraising in mid-2017, the tighter rules on entrusted loans in January 2018, and most importantly, the new asset management rules introduced in April 2018 to rein in high leverage and shadow banking, which limit banks from investing in high-risk and short-term funding vehicles, and requires them to remove “implicit guarantees” on principals and return rates.

Shadow banking assets declined through most of 2018 and 2019. Notably, China’s deleveraging and crackdown campaign sharply reduced the number of P2P platforms to just three from about 5,000 at the peak, Liu Fushou, the chief legal counsel of the CBIRC said at a routine State Council briefing in early November 2020.

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Although the authorities granted a one-year grace period for financial institutions until end-2021 to fully adapt the new asset management rules, which will probably ease the pressure on the shadow banking sector, it does not represent a significant departure from the regulators’ commitment to addressing risk in the financial system.

Apart from providing temporary relief for shadow banking sector, China attaches great importance to the control of financial risks, as it prepares to open its markets wider to private and foreign investors. In particular, the PBOC has signaled far stricter regulation of the fintech companies recently, with providers of micro-lending business to be amongst those worst affected. Chinese regulators also said they would regard Ant and other fintech companies more like banks, and bring all financial activities under a unified scope of supervision.

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Cover Story: Why Ant Group’s IPO May Stay on Ice for a While

Li Zengxin is the director and Li Huizi is an analyst of Caixin Global Intelligence, the research arm of Caixin Global. (

Contact editor Michael Bellart (

This article is part of a 10-part series. You can find links to the others below.

Year in Review: China’s Economy Gets Back on Track, but Faces Long Road Ahead

Year in Review: China’s Careful Exit From Pandemic’s Fiscal and Monetary Policy

Year in Review: China’s Financial Market in 2020 — More Opening, More Regulation

Year in Review: China’s Diplomacy in 2020 ― ‘Wolf Warriors’ in Action

Year in Review: 2020 Exposes Gray Rhino Risks in China’s Financial Sector

Year in Review: Once Darlings, China Tech Giants Face Growing Scrutiny at Home and Abroad

Year in Review: The Year Covid-19 Changed Everything

Year in Review: Drive to Overturn Wrongful Convictions Gains Momentum

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