From Kenneth Ho, Head of Asia Credit Strategy Research
In our view, the recent volatility in the China equity markets is unlikely to have a meaningful spillover effect into the credit markets, similar to what we saw during the Chinese equity market volatility last year. What concerns us is the intensification of capital outflow pressures, with the risk of a larger than expected depreciation and rising credit stresses.
We do not think that the depreciation of the RMB is likely to have a meaningful negative impact on Chinese corporates' credit profiles, based on an analysis we carried out on listed company leverage. Our concern is that the negative impact on risk assets from a larger than expected RMB depreciation could spill over to risk sentiment in the China credit markets, although that is not our base case, as we expect a modest depreciation of the USD/CNY to 7.0 by the end of this year.
From a credit fundamentals perspective, we do expect credit stresses to rise, affected by a combination of slowing growth, weakness in commodity prices and high levels of corporate leverage. This can be seen in non-performing loans (NPLs) in China's banking sector, which reached 1.5% in 2015H1 according to data from the China banking regulator, up from 1.2% at the end of 2014 and 1.0% at the end of 2013. But we do think that this will be a long NPL cycle, with periods of "forbearance" as policymakers seek to underpin growth.
As such, we remain comfortable with China credit risk but would seek to avoid the riskier segments, namely the lower-rated IG names and the commodities and energy-related sectors
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