From UBS via FTAlphaville:
The risk of the debt-deflation trap. Elevated leverage levels, falling prices, weaker real activity and heightened real interest rates all mean that China’s debt servicing burden is rising sharply (Figure 12). As sales revenue and cash flows shrink alongside declining prices, the corporate sector (and local governments) will increasingly lack sufficient cash flow to service their debt. As a result, they will have to increase their reliance on new credit to pay the interest on their existing debt and finance ongoing operations. This means that leverage will continue to rise even as corporate demand for investment and credit stays weak, aggravating China’s already high debt burden (Figure 13). The resulting debt overhang will further weigh on the real economy as enterprises slim down investment and production plans in an attempt to cope with financial pressures, creating a negative feedback loop. In this scenario, banks’ asset quality will continue to deteriorate, pushing up the system NPL ratio (currently at 1.5%). As a result, more credit risk events, e.g., postponing or defaulting on debt repayment, are likely to emerge in the next few years.
…(1) More monetary easing. Although monetary easing on its own is of limited use for supporting real economic growth, it can help to ensure an accommodative environment in which fiscal measures and structural reforms can take root, in order to contain the rise in China’s debt servicing burden and limit any resultant rise in leverage. Both can help to mitigate the deterioration of corporate balance sheets and slow down the pace of NPL formation in the real economy. To the extent that monetary easing fights deflationary pressures and underpins nominal GDP growth, it could also help to stabilize or contain the growth rate of China’s leverage ratio too.
(2) Faster restructuring and exit of excess capacity, unviable firms and bad loans. The government should allow for more bankruptcies and faster restructuring of unviable companies (including SOEs), and push for more rapid write-offs of nonperforming loans and recapitalization of banks. The latter can be facilitated by lowering bank dividend payments, increasing the use of asset management companies, and raising more capital for banks.
(3) Strengthening demand-supportive measures and speeding up key structural reforms. The government will likely need to increase fiscal spending on social welfare, lower labour taxes, further deregulate the services sector, and speed up factor-price reform and hukou reform. Launching serious corporate restructuring by closing excess capacities and zombie companies may also lead to improved business sentiment and margins down the road, and eventually more autonomous and non debt-intensive growth.
UBS is forecasting growth to slow from 6.9-7% in 2015 to 6.2 per cent in 2016 and 5.8 per cent in 2017, and the growth drivers will keep shifting against Australia as “as the ongoing property construction slowdown and excess capacity overhang in the industrial and mining sectors suppress fixed investment and industrial demand.”
Better buy those miners. Not.
