The recent jump in discounted bill financing could entail excessive risks for China’s domestic economy.
China’s new loan growth surged 28% to Rmb703 billion (US$111.2 billion) year-on-year in August from Rmb549 billion in August 2011, according to the People’s Bank of China (PBoC). This was the highest of any August on record as the government attempts to reverse an economic slowdown.
Retail lending was the main driver of new loan growth, while corporate lending is still dependent on discount bills. New corporate loans grew by Rmb421 billion, of which new discount bills accounted for 31.2% of the total.
This shows that effective demand for loans remains weak and banks continue to rely on discount bills – which usually accounts for less than 10% of total loans – to ‘window-dress’ figures, note economists.
“It’s not a good sign because corporates are not committed to long-term borrowing. It’s the recycling of short-term liquidity and not really long-term genuine lending,” declared Zhi Ming Zhang, head of China research at HSBC to Asiamoney PLUS in a telephone interview on September 14. “Genuine lending, meaning it’ll go into the economy.”
Medium-to-long-term lending accounted for 28.6% or Rmb120 billion for the month or 28.6% of total new corporate lending in August. Economists highlight that the amount remains low on an absolute basis.
“It the second-lowest figure year-to-date after July and yet another sign of weak effective demand for loans,” said Nan Sheng, economist at China Commercial Bank International (CCBI).
Discount bills, which were originally designed as a payment tool, are now used by corporates as a short-term financing tool.
These bills are notes from a firm instructing a bank to pay a specific sum to a third party payee on a particular date. But if the payee needs the money earlier, it can cash the bill early for a discount - either at the same bank or a different one.
More entities are beginning to rely on it for funding their short-term working capital cycle as oppose to obtaining long-term loans given the increased difficulty in obtaining the latter, especially for small- to medium-sized enterprises.
Additionally, rising accounts receivables calls for the need of discounted bill financing, as third party payees fail to settle payments on due dates.
Accounts receivable have risen sharply among China's publicly traded industrial companies as growth slows in the world's second largest economy, reducing manufacturing and the demand for a range of commodities.
“The risk is that the bank will have to bear the payment liabilities,” said Wilson Li, China bank analyst at Guotai Juna Securities to Asiamoney PLUS. “Usually the smaller enterprises and privately owned enterprises, such as manufacturing, have relied on the discount bills for financing. These players are more risky than other sectors.”
The top 300 Shanghai and Shenzhen listed companies were owed a total US$244.8 billion from their clients at the end of June, up 20% from US$204 billion six months earlier and about 18% higher than in June 2011, according to Reuters data.
The jump in unpaid bills has alarmed the government.
The Development Research Centre of the State Council, a research unit of China's cabinet, said in a report in March accounts receivables at Chinese industrial companies hit Rmb7.2 trillion and that the situation in the steel, coal and machinery sectors was especially “grave”, according to state media.
“As SOEs (state-owned enterprises) tend to increase their capacity aggressively, their fixed costs have expanded rapidly. When GDP growth is high, SOEs’ revenue growth is usually high, which helps cover the expansion in fixed costs,” said Mingchun Sun, China economist for Daiwa Capital Markets.
“However, when GDP growth slows and revenue growth slows, fixed-cost growth cannot be lowered immediately, putting considerable pressure on profit margins,” he added.