Will China’s deleveraging hit Malaysia?

This article first appeared in The Edge Financial Daily, on August 7, 2017.
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KUALA LUMPUR: As China’s deleveraging efforts continue to raise concerns that a global slowdown, Malaysia’s growing exposure to the Asian giant makes one wonder just how the local economy stands to be affected.

It appears that, so far, Chinese authorities have been clamping down largely on its privately owned entities, requesting that these companies sell their foreign assets and bring the proceeds back home. This reportedly saw property and entertainment conglomerate Dailan Wanda Group scrap its bid for the US$10 billion (RM43 billion) Bandar Malaysia development project.

However, what may be of a bigger concern is the debt carried by Chinese state-owned enterprises (SOEs) to fund their expansions. According to a report by Bloomberg, SOE debt makes up the bulk of non-financial corporate debt, which currently stands at US$17 trillion or some 59% of total outstanding debt of nearly US$29 trillion.

Second Finance Minister Datuk Seri Johari Abdul Ghani has said that Malaysia’s risks are contained as long as the government continues to deal with these SOEs. However, whether or not that will still apply when the time comes for China to trim its debts remains to be seen.

“If you look at China’s credit tightening, a lot of it will have to be done with SOEs because that is where a significant portion of its debt lies,” said Socio-Economic Research Centre (SERC) executive director Lee Heng Guie.

“[That means that] these firms are likely to be much more careful with their assessments of new investments going forward, even though they will probably uphold existing commitments,” Lee told The Edge Financial Daily.

Chinese President Xi Jinping has said that the lowering SOE debt should be made “the priority of priorities”, but most market watchers are hopeful that the world’s second-largest economy will deleverage prudently and be mindful of the domino effect its decisions will have.

“We are not convinced that the rhetoric regarding deleveraging will translate into an actual fall in debt,” said Christian de Guzman, vice-president and senior analyst of sovereign risk at Moody’s Investor Services.

“As such, we think that China can sustain [a] relatively healthy growth of over 6% over the next few years, which should be supportive of demand for Malaysia’s exports, inward flows of Chinese investment, and commodity prices in general,” he told The Edge Financial Daily in an email response.

In any case, a reform of SOEs appears to be a distant goal with no distinct solution yet, since China has no clear-cut way of “credibly disciplining its elder sons”, Deloitte China chief economist Stephen Xu Sitao said.

“The question to ask is whether or not the Chinese government can make budget constraints binding on SOEs,” Xu said at a conference on China’s banking and financial sector last week.

“And while the Chinese are good at making small things big, they are not good at making big things small. How do you consolidate such large SOEs?” he said.

The unlikelihood of the Chinese state rushing to curb the spending of its SOEs has led most experts to conclude that it would not pull back from the multibillion dollar investments it has promised to pump into its Belt and Road Initiative.

“If investments are sanctioned by the [Chinese] state, they will probably be given some leeway when it comes to tightening,” said Dr Yeah Kim Leng, economics professor at the Sunway University Business School.

Where Yeah expects to see tightening in China instead is on the supply side of raw materials such as coal, steel and cement, and zombie companies that have been supported by the Chinese government’s earlier willingness to provide cheap credit.

Meanwhile, Malaysia has been actively courting China’s SOEs for its infrastructure projects, including the RM55 billion East Coast Rail Link for which it signed a memorandum of understanding with China Communications Construction Company (CCCC), the republic’s largest construction outfit. Most recently, the light rail vehicle work package for light rail transit 3 has been awarded to a consortium led by CRRC Zhuzhou Locomotive Co Ltd.

Also worth mentioning is that out of the nine bids for the Bandar Malaysia project, seven have come from Chinese state-controlled companies, with the remaining two from Japanese developers. Putrajaya, in an announcement last month, said the bids are valued between US$7 billion and US$10.5 billion.

Separately, Chinese SOEs are also participating in the development of ports and industrial parks in Melaka and Kuantan, and the Four Seasons Hotel and the Tun Razak Exchange (TRX) Signature Tower here.

Although existing government-backed commitments and projects may remain unaffected for now, private companies that are deemed to be lacking synergies with China’s overall expansion strategy could see further curbs on their overseas expansions, SERC’s Lee said.

“These investments may be put on hold if [the Chinese government] considers the capital outflows too big and unnecessary,” he added.

China has, for example, been taking measures to cool its property market, noted RHB Asset Management chief investment officer, Mohd Fauzi Mohd Tahir.

Speaking to reporters after the asset management arm’s market insight forum last week, Mohd Fauzi concurred that this had translated into a slight slowdown in demand for properties in Malaysia built by Chinese developers, such as Country Garden Holdings Co Ltd’s US$100 billion (RM428 billion) Forest City in Iskandar Malaysia, Johor.

In April, it was reported that Country Garden assured mainland investors that it would refund them following Beijing’s crackdown on capital outflows.

According to a report by Nomura last week, it is possible that China’s highly indebted corporate sector would refrain from investing overseas until its deleveraging is complete.

But while China has been cracking down on the foreign assets of some of its biggest privately owned enterprises, it also saw the launch of 52 state-owned investment firms in 21 of its provinces last week, which will be investing state funds at the provincial and city levels, Reuters reported.

Beijing, however, has given an assurance that it will take steps to keep the deleveraging process smooth and orderly, the wire service quoted the People’s Bank of China assistant governor Zhang Xiaohui as saying.

But whether or not China can fulfil its promises remains to be seen.