China’s companies are being hit by a surge in delays in getting paid for their goods and services, and the implications are grave both domestically and abroad, according to global credit insurer Coface’s latest annual China payment survey. Could this be the push the country needs to tackle its historically low credit insurance penetration levels?
Released last week, the survey makes for sobering reading. After a challenging 2018 as economic expansion fell to 6.6% – its weakest pace since 1990 – a perfect storm of tight liquidity conditions, the ongoing US-China trade war, and lacklustre growth has led to Chinese companies resorting to using longer payment terms to sustain business levels. Coface found that in 2018, average payment terms ballooned to 86 days, up from 76 days in 2017.
But the payment delays keep coming. According to the survey, fully 62% of Chinese businesses were paid late during 2018, and 40% said the length of delays had increased, up from 29% in 2017. What is most concerning, though, is that the proportion of respondents experiencing ultra-long payment delays of more than 180 days which exceed 2% of their annual turnover grew to 55% in 2018, up from 47% previously. According to Coface, 80% of ultra-long payment delays are never paid, and when these delayed payments constitute more than 2% of annual turnover, a company’s cash flow may be at risk – increasing the possibility of insolvency.
For the first time ever, a majority of Chinese businesses told Coface that they feel the economy is unlikely to improve in 2019, which, given cultural sensitivities to responding to such questions in a negative manner, provides the best insight yet into just how depressed domestic sentiment is in the world’s second-largest economy.
Given this increasingly risky environment, one would be forgiven for expecting credit underwriters to reduce their portfolio and exposure in China. Speaking to GTR, Carlos Casanova, Asia Pacific economist at Coface and author of the survey, explains the findings, and outlines why this latest blowout in invoice payment times may actually lead to better opportunities for the credit insurance market in China.
GTR: Payment terms and delays have been increasing steadily in China since 2015. Is this a systemic issue?
Casanova: There are a few reasons for this trend. The economy is decelerating, so companies have to operate in a more competitive environment which often means that the only way to secure business is to offer more generous credit terms to customers.
On the other end of the spectrum, liquidity was exceptionally tight in the first half of last year, which is when we really saw the deterioration in delays take place. A company operating in a tighter environment will struggle to pay on time, which of course is no big deal on an individual basis. However, if all the companies in the system are doing the same thing, it does accrue to quite a lot of credit risk, specifically if companies don’t have the adequate credit management tools in place.
They could be faced by a liquidity crunch, and many of those companies were. There was a big spike in corporate insolvencies in China last year, because all of this was happening at a time when the central bank was trying to control debt and tighten liquidity. We saw a build-up of credit risk in the system, and that translated into a deterioration in payment conditions, both on the terms front and also in the number of companies that experienced delays. This definitely points to an accumulation of credit risk in the Chinese economy.
GTR: With many exporters and supply chains around the world having exposure to China, who stands to lose out?
Casanova: Australia is an interesting example, because a large proportion of their exports to China, such as iron ore, are in sectors where we see accumulation in credit risk, or where the situation is just not favourable relative to other sectors in the Chinese economy. There are other countries who also export a lot of similar types of commodities who need to be cognisant of the risks that are piling up in the Chinese economy. For example Chile, which is a big copper exporter to the region, and Zimbabwe, an important metals exporter.
We also see a deterioration of conditions in the ICT sector, and that supply chain is very Asia-dominant. Countries such as Malaysia, South Korea, Taiwan and even the Philippines have to be very careful about how they are managing risk in terms of their supply chains in China.
GTR: How likely is government intervention?
Casanova: We anticipate that the government will step in to alleviate some of the pressure. One of the sources of this credit risk accumulation in 2018 was the fact that the authorities went about tightening in a way that was perhaps more aggressive than necessary. That didn’t help companies that needed to access financing in order to make repayments. The government has since moved to change this and the monetary policy stance is now more accommodative than it was 12 months ago.
With that being said, in China there is always a policy dimension. Certain sectors are considered more relevant than others, and while we do see that the government would continue to support key sectors in ICT and certain sub-segments within the automotive industry, it is unlikely that they will stop their campaign to remove corporate debt in sectors such as construction or energy. We have seen an intensification of reform policies in those sectors, in particular in the energy sector. There is the likelihood that going into this year there will be a lot of companies that will feel the impact of the reshuffling in that sector.
GTR: Is this good news for credit insurers, or will insurers start considering pulling cover given the accumulation of credit risk in China?
Casanova: One of the interesting findings of the survey is that a large proportion of respondents – 40% – don’t actually use any credit management tools, with only 20% purchasing trade credit insurance or credit reports from providers such as Coface. Given the context of there being a pile-up in credit risk, the market shifting towards a more commercial approach to dealing with insolvencies, and the government now a lot more comfortable in allowing companies to go bankrupt, that creates an environment whereby demand for professional credit management tools increases, which is of course good for credit insurance companies.
China remains a big market for all of the credit insurers, so we are not yet in a situation whereby people are quitting the market. In fact, the conditions are actually quite good for there to be a more professional or market-based approach to handling credit risk in China. It’s a matter of increasing your appetite in a way that makes sense. Some sectors will just be more attractive than others in terms of their credit risk. In general, in the pharmaceuticals, chemicals and agrifood sectors there was a very small proportion of respondents who said they were seeing very long payment delays which accounted for a sizeable proportion of their annual turnover. Meanwhile, in the construction and the automotive sectors a lot of companies have a sizeable amount of their turnover that is tied up in these ultralong unpaid amounts. The risk of something going wrong in those sectors is higher and credit insurers will take a much more proactive approach to how they expand in those fields.