Workers cut up coal carts in December 2019 at a coal mine in Mentougou, west of Beijing, where many mines were closed as China sought to cut CO2 emissions.

Greg Baker | AFP | Getty Images

BEIJING – China’s bond defaults are increasingly concentrated in part of the country whose growth may be under greater pressure from tough new carbon emissions restrictions, according to an analysis by Nomura.

Fifteen regions in the northern half of China, including Beijing and Inner Mongolia, accounted for 63.4% of government bond defaults last year, up from 51.5% in 2019, Nomura said in an April 27 report .

This is the latest sign of growing economic inequality within the country, where GDP and population growth in the north are already lagging behind those in the south. China’s promise to cut CO2 emissions by 2030 now means that the northern region’s economy has production restrictions.

“The new environmental campaign has the potential to hit northern China – where a large part of steel, aluminum and other raw materials are manufactured and processed – particularly hard,” wrote the Nomura analysts.

“Since most of these steel and aluminum mills are located in lower tier (less developed) cities, these cities’ public finances are likely to be disproportionately affected, increasing the risk of credit default,” they said.

Historical factors

There are many state-owned companies and heavy industries in northern China. This meant that the region was disproportionately affected from the late 1980s when China began to reduce the role of state-owned companies in the economy, which resulted in many workers losing their jobs.

Meanwhile, southern China has more export centers such as Guangdong and Jiangsu provinces. The region has Shanghai and Shenzhen among its capitals and was an early beneficiary of China’s move to allow more foreign and privately owned companies to enter the relatively closed domestic market.

According to the Nomura analysts, historical factors and overcapacities built up after the financial crisis of 2008 contributed to a further weakness in the north. They estimate that northern China contributed only 35.2% of the national nominal GDP last year, while GDP per capita was only about three-quarters of southern China’s GDP.

The north is also more dependent on debt. The share of outstanding corporate bonds in GDP in northern China rose to 52% in 2020 compared to 30% in southern China, Nomura said.

“The north-south divide could become an important factor in credit differentiation in the coming years,” the report said. “Indeed, we have already seen some deterioration in the ability of northern China’s provinces to obtain funding from the bond markets.”

The north accounted for 10% of national corporate bond issuance in the first quarter, compared to 42% for all of last year, analysts said.

Investors are wary of larger risks

Pressure on the north is mounting as defaults in China rise overall, particularly among state-owned companies that investors previously believed had implicit government support.

While the level of defaults is still quite low compared to the overall market, the trend will push investors to differentiate between different issuers of bonds, said Ivan Chung, head of Moody’s credit research and analysis team in China.

According to Chung, issuers canceled bonds last month for two different reasons. One is that the issuer is too weak to arouse enough appetite for investors, he said. The other is that despite the good quality, market sentiment has driven the cost of the bonds up and made them too expensive.

Amid some signs of growing concern, investors feared in April that state bad debt manager Huarong would be unable to make payments.

Separately, 24 companies backed by the Henan provincial government plan to set up a 30 billion yuan ($ 4.6 billion) fund to help local businesses deal with debt risks, Chinese financial media website Caixin reported below Appeal to a government official. Henan is part of Nomura’s name “Northern China”.

Financing a renewable energy relocation

As China tries to balance growth with reducing carbon emissions, easing pressure on carbon-intensive projects may not be enough. Privately owned renewable energy companies may have difficulty obtaining funding from a system in which the largest banks are state-owned and prefer loans to similarly state-backed companies.

One option to fund renewable energy projects may be to issue “green” bonds, which Reuters said sold $ 15.7 billion in China in the first quarter, citing data from Refinitiv. That volume was almost four times what it was a year ago, the report said.

Foreign investment organizations such as the International Finance Center affiliated to the World Bank have also become increasingly involved. Some of the project plans IFC lists on its website for China include wastewater treatment and solar energy.

The size of IFC funding in China has increased from $ 500 million a year 15 years ago to $ 1 billion a year more recently, with about 60 percent being climate-related, said Randall Riopelle, acting regional director for East Asia and the Pacific and Country Manager for China for IFC.