Rising external debt suggests both the advancement of China's opening up and its steady economic recovery
By Li Xiaoyang  ·  2021-01-19  ·   Source: NO.3 JANUARY 21, 2021
Engineering equipment to be shipped abroad is loaded at the Lianyungang Port in Lianyungang, Jiangsu Province in east China, on December 7, 2020 (XINHUA)

China's outstanding foreign debt was more than $2.29 trillion at the end of the third quarter of 2020, up 7.6 percent from the end of the second quarter, according to the State Administration of Foreign Exchange (SAFE).

Foreign debt covers the amount of a country's total borrowing from external sources, including commercial banks, governments and international financial institutions. SAFE spokesperson Wang Chunying said the quarter-on-quarter increase in foreign debt was the result of China's accelerated opening-up efforts and steady economic recovery, with international investors continuing to increase holdings of Chinese bonds and outstanding trade credit and prepayment growing due to improved imports and exports.

Despite uncertainties brought about by the novel coronavirus disease (COVID-19) pandemic and an unpredictable external environment, China's foreign debt will remain stable amid sound domestic economic growth, she said.

According to SAFE, China's outstanding foreign debt surged to more than $2.05 trillion in 2019 from $15.83 billion in 1985. The ratio of short-term debt, with an original maturity of one year or less, to foreign exchange reserves, a key indicator of foreign debt affordability, stood at 38.8 percent in the year, well below the globally recognized warning line of 100 percent.

"China has witnessed rapid economic growth in recent years and attracted more foreign investment with policies that facilitate overseas financing and the inclusion of yuan-denominated bonds on more global benchmark indices, gradually improving its foreign debt," Wen Bin, chief analyst with China Minsheng Bank, told Beijing Review, adding that China's sufficient foreign exchange reserves can largely hedge possible risks.

Sensible use

China has phased out restrictions on foreign debt financing in the past few years. Main measures include the modification of the macro-prudent adjustment parameter that determines the upper limits of outstanding cross-border financing one institution can reach and the launch of various pilot programs that allow hi-tech enterprises in more regions to borrow money from overseas.

The Chinese Government used to have in place strict management of foreign debt, banning many small and medium-sized enterprises from external borrowing and capping the amount of financing.

To boost the growth of domestic enterprises and help them go global, the People's Bank of China, the central bank, and SAFE introduced the macro-prudential adjustment parameter in 2016. The regulators also removed some approval requirements for foreign debt borrowing and unified management policies to level the playing field.

When COVID-19 disrupted production and caused financial strains in many companies in the first months of 2020, the financial regulators raised the parameter on cross-border financing for financial institutions from 1 to 1.25 in March. "The move helped enterprises, especially small, medium-sized and private ones, raise funds through multiple channels and lower their financing costs," Wen said.

As China's economy recovered and the yuan continued to appreciate in recent months, the parameter was once again lowered to 1 on December 11, 2020, which, according to Wen, is conducive to guarding against possible defaults caused by the rapidly increasing level of debt of domestic enterprises.

But the macro-prudential adjustment parameter benefits mainly enterprises with large net assets, whereas hi-tech startups in the initial phase find it more difficult to gain foreign financing, Ye Haisheng, Director of the Capital Account Management Department at SAFE, said in an article published by China Forex magazine last year. Therefore, the government introduced a pilot program to broaden financing channels for hi-tech enterprises in 2018 in Beijing's Zhongguancun Sci-Tech Park. It facilitated cross-border financing of small and medium-sized hi-tech firms.

In March 2020, SAFE expanded the program to Shanghai as well as Hubei Province in central China and Guangdong Province in the south.

Risk control

While continuing to open up the financial market, SAFE has improved precautions for possible risks from cross-border capital flow.

According to Ye, the COVID-19 pandemic has delivered a heavy blow to market confidence despite central banks of the United States and major European economies launching massive quantitative easing programs, with the prices of bulk commodities such as gold and crude oil slumping.

Under the circumstances, Chinese enterprises face severe challenges caused by fluctuating exchange rates in cross-border financing.

However, Ye believes that the risks facing China's foreign debt are controllable. The indicators, including its liability on asset ratio, debt to GDP ratio, debt service coverage ratio and the ratio of short-term foreign debt to foreign exchange reserves, are currently within the safe range, he said.

"Although the improvements in the outstanding trade credit and prepayment for China's booming imports and exports can drive up short-term foreign debt, the cross-border financing for trade does not need to be settled in foreign currencies, thus not escalating the risks of foreign debt," Wen said.

Ye also attributed the expansion of foreign debt to the increasing holdings of Chinese bonds by foreign investors, mostly central banks and large financial institutions, as China's financial market further opens up.

China issued its first negative-yielding sovereign bond, a euro-denominated deal, on November 18, 2020, which became a hit among investors.

According to Wen, international investors, especially large institutions, expect more returns through investing in sovereign bonds at lowered risks in the midst of a volatile international financial market. Upbeat about China's economic prospects, they have increased their holding of yuan-denominated assets.

"The advancement of the reform of the yuan's exchange rate formation regime will help improve the management of foreign debt, but effort is required to fend off possible risks in cross-border financing through tightened monitoring to curb speculation and stabilize the value of the yuan," he said. "Enterprises also need to make sensible use of foreign debt financing and financial derivatives to protect them from potential risks." BR

(Print Edition Title: In Good Debt)

Copyedited by Elsbeth van Paridon

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