As Chinese corporates deleverage, their main problem now is waning revenue

Macro trends often go hand in hand with corporate performance. Although the cyclical rebound is helping the Chinese economy bottom out from the quagmire of zero-Covid, the recovery so far is weaker than expected and structural headwinds are pressuring potential growth. For the corporate sector, limited economic recovery, high uncertainty about future – worsened by the heightened strategic competition with the US – and deflationary pressures can pose further challenges.

In?Natixis China Corporate Monitor Series 2023, we compare 3000 Chinese and 3000 global firms, starting with a general analysis identifying the macro factors impacting corporate health in China and its relative performance with international peers. The combination of economic and corporate data will provide important coverage on evolving trends, which are essential for policymakers, corporates and investors in formulating strategies to capture opportunities and manage risks.

Outlook complicated by early signs of balance sheet recession, geopolitics, and deflationary pressure

Beyond decelerating economic growth, the concern on government debt means the room for fiscal stimulus is limited. A major worry is the early signs of balance sheet recession, which is a consequence from weak confidence and fast regulatory changes. Such potential remake of Japan's dilemma in the late 1980s means corporates and households are uncertain about future, opting to limit investment and consumption to pay down their debt through deleveraging. However, regulatory-neutral sectors are likely to receive more government support and subsidies.

Externally, the low inflation environment in China means corporate revenue will not grow as quickly as peers. Most Chinese firms also find it hard to pass the cost to consumers. Geopolitics is by far the biggest risk and will cast a shadow on China's corporates as the world eyes more on supply chain security and de-risking, such as?the US-led multi-country chip ban?and the Inflation Reduction Act.

The challenges and structural changes in the Chinese economy and the corporate sector have led to a revaluation of China-related assets, especially as investors cannot access the policy risks. There is not enough comfort for investors to rewrite the growth story, and yield differentials has led to a persisting bond selloff.

More downside on revenue than lower leverage and interest rates

Between 2021 and Q1 2023, China and global peers faced different challenges. China's overall corporate health is supported by deleveraging and lower interest rates, but the decline in revenue has offset any meaningful development on debt, leading to a weaker repayment ability. In contrast, global firms have seen pressure from rising interest rates, but they managed to achieve decent revenue. As measured by EBITDA-to-interest expense, China’s corporate repayment ability worsened from 7.0x to 5.9x, drawing a sharp contrast with the improvement from 11.1x to 11.8x by global peers.

Regarding capital efficiency, there is also a deterioration in China's return on capital (ROC), which appears to be a structural trend. The lower return on capital – coupled with increased uncertainties both in domestic demand but also geopolitics – probably explains why Chinese firms have stepped back from fast capex growth, which has decelerated from 20% in 2021 to 1% in the first quarter of 2023.

Implications: Concern about the inability to generate fast revenue growth

With the increasingly compelling risks of deflation and geopolitics, deleveraging at the current juncture with reduced income growth, profit margin and capex may hint at more downside for the waning revenue and poorer confidence. It reflects that the scarring effect of zero-COVID and tightened regulatory environment has a prolonged impact on corporate and household sentiment. The trends may create a negative spiral in China’s corporate repayment ability if the revenue slowdown is more than a cyclical downturn and credit polarization becomes more obvious. Although interest rate may fall further, concerns are growing about Chinse firms’ inability to generate as fast revenue growth as in the past, as well as their already low return on capital, which will have implications on both macro and corporate levels.

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