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Deleveraging? Chinese corporate leverage is getting higher

Chinese companies see leverage rise despite the country’s deleveraging campaign and in particular, small-sized private companies, hit by the country’s supply-side reform and deleveraging campaign, see leverage rise significantly with slowing profit growth and worsening cash flows.

Average debt-to-asset ratio of A-share listed non-financial companies increased to 61.1 per cent by the end of June, higher than 60.5 per cent at the end of last year, according to data compiled by China International Capital Corporation.

That’s compared to 60.8 per cent one year earlier and a peak of 61.5 per cent in 2014.

For a breakdown, those listed on the mainboard, most of which are big-sized state-owned enterprises (SOEs), have witnessed slight rises in leverage, while firms listed on Chinext board and SME board, most being smaller-sized private companies, saw debt-to-asset ratio rise 0.7 and 0.72 percentage point respectively, according to the CICC.

In particular, sectors including infrastructure, ports and shipping, consumption, electricity power generation and real estate sectors posted relatively bigger increase in leverage, while upstream sectors that benefit from the country’s supply-side reform, such as steel, coal, construction materials and chemicals saw leverage substantially lower.

The conclusion is echoed by Zhang Xia, chief strategist at China Merchants Securities. “Cyclical sectors such as coal mining, steel making and non-ferrous metal production are seeing leverage getting lower, said Zhang.

Coal mining sector’s debt-to-asset ratio declined to 49.12 per cent by the end of June to 50.76 per cent at the start of the year and steel making sector’s debt-to-asset ratio fell to 60.99 per cent from 62.61 per cent six months earlier, according to data compiled by the China Merchants Securities.

China’s efforts to cut capacity in the steel and coal sectors have boosted steel and coal prices and the sector’s profits, helping reduce leverage in these companies, said Tang Jianwei, macro analyst at the Bank of Communications.

Notably, in recent years, improvement in leverage and debt repayment indicators in SOEs, traditional economies and other big-sized companies always came with worsening of the same indicators in small-sized private companies, according to the CICC.

“Cash flow is weakening in small-sized private companies, indicating that leverage ratio in these companies increased passively, the CICC points out.

Leverage in upstream sectors declined as profits in corporate sectors concentrated to these sectors following the supply-side reform, so the sustainability of the decline is in doubt, especially so considering  declining profits in downstream sectors, according the CICC’s report.

Chinese small companies have been facing more challenges as China push forward with a deleveraging campaign. While profits are squeezed by bigger companies, its financing activities are getting more difficult by the government’s crackdown on shadow banking.

Of the seven companies that experienced their first bond default in the onshore market in the first five months of this year, six were privately owned, according to Zhou Hao, president of China Chengxin International Credit Rating Co, a joint venture with Moody’s.

Since 2015, the central leadership has stressed supply-side structural reform, with major tasks including tax cuts, lowering corporate costs, tackling overcapacity, reducing inventories and deleveraging.

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