February 21, 2020
One of the main questions vexing markets, is the degree to which the coronavirus will weigh on growth in the world’s second largest economy. With a fraction of the Chinese economy functioning at this point, certain businesses are finding it increasingly difficult to meet their financial obligations. Back in 2016, President Xi Jinping embarked on a deleveraging campaign that led to a crackdown on shadow banking. Since then, the credit cycle has accelerated and defaults have increased dramatically. Moreover, both investment grade and high yield borrowers have seen credit spreads over government debt escalate to the highest figures since November of 2019. Even though the Chinese government has responded with easier liquidity policies, the funding is not finding its way to smaller private companies, which accounted for more than 80% of the defaults in 2019. With domestic market bond defaults totaling a record 137.6 billion yuan ($19.7 billion) last year, the impacts of the coronavirus will only exacerbate the credit cycle. But, based on 5-year Chinese sovereign credit default swaps, which are trading at 35 basis points (bps) and is well below the 17-year average of 70 bps, the market is confident that the central government has the financial means to absorb the economic impacts from this epidemic. An additional headwind to growth facing China pertains to the country’s aging demographic profile. Back in 1979, China enacted the one-child policy due to food and housing shortages the nation was facing at the time. In 2016, however, China revised the policy to allow for up to two children, but it has not helped increase birthrates. Furthermore, there were only 14.6 million births in China in 2019, which was the lowest figure since 1961. It is projected that by the year 2030, China’s population will peak at 1.45 billion people and in 2040 24% of the population will be 65 or older. There is no question that China is facing a demographic headwind and even though it has the capacity to handle the issue now, it could unfortunately become progressively more difficult.
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