Corporate debt-market instability could worsen the economic outlook in China as it deepens the financial squeeze that small and medium-sized firms have to endure, a new report said on Friday.

China’s corporate bond default nearly quadrupled last year to 120.96 billion yuan from a year earlier. And things have not shown a sign of improving this year as corporate debt defaults from January to July amounted to just under 71 billion yuan, 60% of last year’s default, the report said.

The report by the Korea Center for International Finance (KICF) cited three issues for the rising defaults: increased maturity, economic slowdown, and strengthened government regulation on debts.

Corporate China rapidly increased its debt issuance after the global financial crisis due to low-interest rates and loosened government regulation. The maturity of corporate bonds soared 47% per annum from 2017 to 2019.

Now, the economic slowdown caused by the US-China trade dispute has weakened the profitability of Chinese corporates, hurting their capacity to pay back debts.

Stricter Chinese government regulations on corporate bond issuance and shadow banking has also led to difficulties with corporate borrowings as funding has become more limited.

Greater impacts feared

“Amid a delay in corporate restructuring, there are fears of credit risk spreading to smaller banks from corporates despite the Chinese government’s stimulus policy, as the prolonged US-China trade dispute has greatly dampened economic sentiment,” KCIF said. “If the real estate market shrinks, the impact could be increased.”

In China, real estate is used as collateral for corporate bonds. And the real estate sector has the most substantial chunk of corporate bonds due to mature next year, with 35.6% of Chinese corporate bonds due in 2020, the report said quoting Wind, a Chinese data service provider.

KICF also pointed out that increasing defaults on corporate bonds may cause the primary market to shrink by weakening investor sentiment. That, in turn, could lead to another vicious cycle of default.

Positive factors

However, KICF said the rising credit risk is not likely to lead to an economic crisis due to China’s high savings rate and the government’s policy to reduce debt.

It said the ratio of Chinese corporate debt dipped to 151.6% at the end of 2018, from a peak of 162.6% in the first quarter of 2016.

Meanwhile, the People’s Bank of China cut the one-year Loan Prime Rate (LPR) by a margin of 5 basis points to 4.2% following a 50-basis-point cut in the reserve requirement ratio early this month. A lower LPR leads to lower corporate borrowing costs.

The PBOC set the Loan Prime Rate at a new benchmark lending rate last month.

But the Chinese central bank remains cautious about pumping liquidity due to the still high debt ratio.

The five-year LPR and the medium-term lending facility (MLF) remained at 4.85%, and medium-term lending facility, which is the base rate of LPR, was also unchanged at 3.3%.