China’s efforts to reduce carbon emissions increase risks for the north

Workers cut coal carts in December 2019 at a coal mine in Mentougou, west of Beijing, where many mines have been closed as China strives to cut carbon emissions.

Greg Baker | AFP | Getty Images

BEIJING – China’s bond defaults are increasingly concentrated in a part of the country whose growth could face increased pressure from tough new restrictions on carbon emissions, according to a Nomura analysis.

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

This is the latest sign of growing economic disparity within the country, where GDP and population growth in the north is already lower than in the south. Now, China’s commitment to reduce carbon emissions by 2030 means production restrictions are coming for the economy of the northern region.

“The new environmental campaign has the potential to reach northern China – where a majority of steel, aluminum and other raw materials are produced and processed – especially hard,” Nomura analysts wrote.

“Since most of these steel and aluminum factories are in low-level (less developed) cities, the public finances of these cities will likely be disproportionately affected, adding to the risk of credit defaults.” , they said.

Historical factors

Northern China is home to many state-owned enterprises and heavy industries. This means that the region was disproportionately affected from the late 1980s, when China started to reduce the role of public enterprises in the economy, resulting in the loss of their jobs for many workers.

Meanwhile, South China has more export centers like Guangdong and Jiangsu provinces. The region counts Shanghai and Shenzhen as its main cities and was one of the first beneficiaries of China’s decision to allow more foreign and private companies into the relatively closed domestic market.

Historical factors, along with the overcapacity accumulated after the 2008 financial crisis, contributed to further weakness in the north, analysts at Nomura said. They estimate that northern China contributed just 35.2 percent of national nominal GDP last year, with a per capita GDP roughly three-quarters that of southern China.

The north is also more dependent on debt. Outstanding corporate bonds as a percentage of GDP in North China rose to 52% in 2020, compared to 30% for South China, according to Nomura.

“The north / south divide could become an important differentiator of credit in the years to come,” the report says. “Indeed, we have already observed some deterioration in the ability of the provinces of northern China to obtain financing in the bond markets.”

The north accounted for 10% of national corporate bond issuance in the first quarter, up from 42% for the whole of last year, analysts said.

Investors wary of higher risks

Increased pressure on the north comes as defaults mount in China as a whole, especially among state-owned companies that investors used to assume had implicit government backing.

Although the level of defaults is still quite low compared to the market as a whole, the trend will cause investors to differentiate between different bond issuers, said Ivan Chung, head of the research team and Moody’s Credit Analysis for Greater China.

Chung said issuers canceled the bond issuance in the past month or so for two different reasons. One is that the issuer was too weak to attract enough investor appetite, he said. The other is that, despite good quality, market sentiment has driven up the cost of bonds, making them too expensive.

In some signs of growing concern in April, investors feared that Huarong, a government-owned bad debt manager, is reportedly unable to make his payments.

In addition, 24 companies supported by the provincial government of Henan plan to create a fund of 30 billion yuan (4.6 billion dollars) to support local companies in the event of debt risks, Report from Chinese financial media site Caixin, citing a government official. Henan is part of the Nomura designation of “North China”.

Financing a transition to renewable energies

As China watches balancing growth with reducing carbon emissions, reducing pressure on high carbon projects may not be enough. Private renewable energy companies may find it difficult to secure financing from a system in which the largest banks are state-owned and prefer to lend to also state-backed companies.

An option to finance renewable energy projects can be the issuance of “green” bonds, including $ 15.7 billion was sold in China in the first quarter, according to Reuters, citing data from Refinitiv. That volume was almost four times what it was a year ago, according to the report.

Foreign investment organizations such as the World Bank-affiliated International Financial Center have also become increasingly involved. Some of the project plans listed by IFC on its website for China include wastewater treatment and solar power.

The scale of IFC’s funding in China has grown from $ 500 million per year 15 years ago to $ 1 billion per year more recently, of which about 60% is climate related, said Randall Riopelle, regional director Acting for East Asia and the Pacific and Country Director for China for IFC.

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