China’s state-owned enterprises and local governments face ‘much tighter credit,’ economist predicts

SINGAPORE — The Chinese economy enters 2021 following a strong bounce back from the coronavirus pandemic and Deutsche Bank’s Michael Spencer predicts that deleveraging will return as a focus for the country’s authorities.

“One of the key concerns that investors domestically and abroad have had about China over the last few months is the growing number of defaults,” Spencer, chief economist and head of research, Asia-Pacific, at the bank, told CNBC’s “Squawk Box Asia” on Monday.

“I think what we’re going to see in 2021 … is a return to deleveraging as an important explicit objective of the Chinese government,” he said. “I think what you’re going to see is … much tighter credit to local governments and to state-owned enterprises.”

A series of recent high-profile defaults by state-owned Chinese firms spooked investors and raised questions over the state of the country’s credit market. These government-supported enterprises were previously seen as safer investments because they rarely defaulted.

Defaults are expected to rise, Spencer said, adding that credit risk in China will become “increasingly important” both for foreign as well as domestic investors.

That, however, may not necessarily be a bad thing.

“This is something that, you know, we have wanted for decades,” Spencer said. “It’s something that China needs — a more sensible approach to lending, a greater credit discipline … and more market discipline over companies.”

Spencer warned, however, that the Chinese economy’s “growth impulse is beginning to weaken.”

The country was virtually frozen in the early part of 2020 after authorities implemented strict lockdowns to curb the spread of the coronavirus. The economy bounced back in the following months.

“If you look over the next four quarters, annual average GDP numbers are gonna be very biased by exaggerated year-on-year effects in the first half of 2021,” Spencer said.

Major economies around the world are experiencing the “worst outbreaks” of the coronavirus that they’ve had to date, Spencer said, with social distancing restrictions being tightened in parts of Europe and the U.S.

In Asia, Japan’s prime minister said Monday the country’s government was considering declaring a state of emergency in Tokyo and neighboring prefectures after a recent rise in Covid cases, according to local media reports.

“It’s not gonna be, I think, until the third quarter of this year at best, before enough people have been vaccinated that … we can begin to relax some of these social distancing rules,” he said.

For the Chinese, that means that the focus will shift toward domestic demand to “keep the economy going” for at least the first half of the year before exports hopefully recover in the second half, the economist said.

“In a year’s time, we expect to see a Chinese economy growing 5.8% year on year,” Spencer said.