The widening north/south divide could result in a vicious cycle of rising defaults and slower growth in northern China. Though we do not expect a national crisis, markets should be prepared for more defaults.
China’s onshore debt market has experienced a rapid rise in defaults in recent quarters, while offshore dollar bond defaults were also near record highs. China’s north/south divide, which refers to the economic disparity between China’s northern and southern regions, has become more evident in recent years by these delinquencies and repayment pressures in debt markets. We expect this divide to worsen as policymakers rein in property market financing and enact carbon neutral environmental policies, which could result in a vicious cycle of rising defaults and slower growth in northern China.
The economic gap between northern and southern China has increased significantly over the last decade, with the southern region benefiting from its dominance in exports, the internet boom and more market-based reforms. On the other hand, the resource-rich northern area has suffered from slowing fixed asset investment, declining commodity prices, and an aging population due to strict implementation of the one-child policy over the last two decades of the 20th century.
Before 2012, the divide was not a big issue, with the southern region benefiting from booming exports and robust light industries, and northern part profiting from resource-focused and infrastructure-led investments. Since then, economic drags felt across the country due to industrial overcapacity, debt build-up, a cooling property sector and the anti-corruption campaign, meant northern China had to bear the brunt as it was more heavily exposed.
Unsurprisingly, Covid-19 also contributed to the widening of the divide. Although all of China’s economy was severely affected by the pandemic, southern China fared better than its northern counterpart. As home to many large internet companies including Alibaba and Tencent, the southern China benefited from the social distancing-driven boom of the internet economy. Additionally, during the country’s rapid economic recovery, which began in Q2 2020, exporters in the region were able to stage a sharp turnaround towards the end of 2020.
The disparity is expected to widen for two reasons:
For bond investors, risk premia for debt issued in northern China are rising rapidly, and investors will need to closely monitor markets as these risks unfold. Treating China as a uniform whole is not a sound approach to credit pricing, and understanding the north/south divide and its implications is crucial to risk analysis. Healthy macro data at the country level can conceal the magnitude of the divide between the two regions.
The impact of the north/south divide on policymaking:
For further insight into China’s credit risk disparity, read our full report.
Chief China Economist
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