HONG KONG • Chinese borrowers are taking on record amounts of debt to pay interest on their existing obligations, raising the risk of defaults and adding pressure on policymakers to keep financing costs low.
The amount of loans, bonds and shadow finance arranged to cover interest payments will probably rise 5 per cent this year to a record 7.6 trillion yuan (S$1.7 trillion), according to Beijing-based Hua Chuang Securities, whose lead fixed-income analyst was top-ranked by China's New Fortune magazine in 2012 and 2013.
Dubbed "Ponzi finance" by Hyman Minsky, the use of borrowed funds to pay interest was seen by the late US economist as an unsustainable form of credit growth that could precipitate financial crises.
Chinese firms are struggling to generate the cash flow needed to service their obligations as economic growth slows to the weakest pace in 25 years and corporate profits shrink.
While the debt burden has been eased by six central bank interest-rate cuts in 12 months and a tumble in corporate borrowing costs to five-year lows, the number of defaults in China's onshore corporate bond market has increased to six this year from just one last year.
"Some Chinese firms have entered the Ponzi stage because return on investment has come down very fast," said Mr Shi Lei, the Beijing-based head of fixed-income research at Ping An Securities, a unit of China's second-biggest insurance firm.
"As a result, leverage will be rising and zombie companies increasing."
China Shanshui Cement Group became the latest company to default on yuan-denominated domestic notes last week as overcapacity in the industry hurt profits and a shareholder dispute stymied financing.
State-owned steelmaker Sinosteel, which pushed back an interest payment on a bond last month, postponed it again this week.
Plunging borrowing costs have made it less expensive for Chinese companies to gain access to fresh cash. The rate on five-year corporate debt with AAA ratings dropped to a five-year low of 3.69 per cent on Oct 29 and was last at 3.95 per cent.
At the same time, policymakers are taking steps to ensure credit keeps flowing to borrowers in need.
Chinese banks should not cut or withdraw lending to companies in "temporary" difficulties, Premier Li Keqiang said last month.
The People's Bank of China has cut its benchmark one-year lending rate to 4.35 per cent from 6 per cent a year ago, helping to fuel 6.6 per cent growth in outstanding corporate bonds this year to 19.2 trillion yuan as of last month.
"Defaults will probably keep rising as profits fail to keep up with interest expenses at some Chinese borrowers, according to Mr Zhou Hao, a senior economist at Commerzbank in Singapore.
"We will see more defaults and rising bad loans in the financial system," he said.