Pimco Sees China Deleveraging Softening in 2018 on Slowdown

(Bloomberg) -- China's campaign to curb financial leverage, which pushed bond yields to three-year highs in 2017, may become less intense this year as growth in the economy decelerates, according to Pacific Investment Management Co.

Roland Mieth, emerging market portfolio manager at Pimco, said China achieved good progress in deleveraging last year. A Bloomberg survey of economists last month showed expectations for more stabilization, with total debt likely to be 260 percent of gross domestic product at the end of 2018, the same as a year earlier.

Milder steps to trim excess debt could help lower financing costs, potentially giving weaker borrowers some breathing room after investors said they expect more such firms to default this year. Mieth's comments echo other remarks from Pimco in October that authorities would refrain from broad-based deleveraging. The market has started pricing in such expectations. China's government and corporate bonds returned 1.9 percent in the first three months of 2018, the best quarterly performance in two years.

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“The new element this year is that growth momentum is probably going to slow down,” with the economy likely expanding at about 6.4 percent from 6.9 percent last year, said Mieth in Singapore. “The pace of financial deleveraging may be more gradual and less intense than last year.”

Still, Mieth said it's not a sign that the deleveraging campaign is ending.

“We still think more will come,” said Mieth. “Because of that we are closely monitoring onshore developments on that front.”

Mieth said he expects local bond defaults to continue to happen in the near term, primarily from the private sector, while state-owned companies and local government financing vehicles will still enjoy some government and bank support.

“Over the long term, there is a recognition that defaults in China will increase,” he said. “It's not necessarily a negative event for the development of China's onshore financial market. Efficient and well-implemented risk allocation is important for international investors to actively invest in the onshore corporate bond market.”

Mieth said it's possible that there may be a first-ever bond default by a local government financing vehicle this year. The units that amassed record debt in the borrowing-and-building binge after the global financial crisis haven't missed any bond payments yet.

“Even if an LGFV defaults, it will be allowed to default by the government and the regulators in a way that doesn't jeopardize the overall financial stability in China,” said Mieth.

To contact Bloomberg News staff for this story: Judy Chen in Shanghai at xchen45@bloomberg.net.

To contact the editors responsible for this story: Andrew Monahan at amonahan@bloomberg.net, Ken McCallum

©2018 Bloomberg L.P.

With assistance from Judy Chen