Warning Signs Series: China’s rising yield might spark trouble for indebted corporate sector

As of 2017, China has around $1.5 trillion worth of external debt, which is not very large when compared to China’s $11.9 trillion GDP, however, China’s trouble lies in the domestic debt market, where total debt has reached more than 200 percent of GDP. Corporate China accounts for the majority of the domestic debt. As of 2016, Corporate China’s debt level was 170 percent of GDP. Since the Great Recession of 2008/09, corporate debt has soared as companies benefited from lower interest rate and debt service costs.

However, yields have started rising, not just in China but all around the world as global major central banks, which have printed money since 2008/09 looking follow the path of U.S. Federal Reserve which has increased interest rates by 100 basis points since December 2015.

Moreover, China’s yield curve remains inverted. Yields on five-year and seven-year debt have remained above benchmark 10-year yield, pointing to trouble in the medium term. This week, China’s 10 year yield has breached the 4 percent threshold for the first time since 2014. The cracks will be more visible, once the interest rates start rising in Europe, possibly in 2019. While the Chinese government does have the resource to tackle the issue, it can’t do so while challenging the Impossible Trinity, which states that interest rates and a fixed or managed exchange rate regime can’t be maintained while capital flows freely in and out of the economy.