## 8. Sensitivity Test Results of the Combined Interest Rate and Profit Shocks

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### I. Purpose and overview
- Objective: document dynamics of corporate indebtedness using firm-level listed-firm data (2003–2013); assess level and distribution of debt and leverage over time, by firm type and industry; assess financial indicators and gauge leverage risk under adverse scenarios.
- Key findings:
  - While, on average, Chinese private listed firms have scaled back their leverage ratio since the global financial crisis, SOEs’ leverage at the tail end of the distribution has significantly increased.
  - The rise in leverage has largely been driven by firms in real estate and construction and in mining and utilities.
  - An increasing share of debt and liabilities is attributed to a few firms with high leverage ratios.
  - Real estate and construction firms (both private and state-owned) enjoyed lower borrowing costs after the GFC, controlling for firm characteristics, allowing them to withstand modest interest rate shocks if the shock applies only to loans and bonds.
  - Private firms in manufacturing are vulnerable to interest rate increases due to thin profit margins.
  - Central SOEs would experience the largest rise in debt at risk with an increase in interest rates.
  - A 20 percent decline in real estate and construction profit could raise total debt at risk to about a quarter of total debt of listed firms.

### II. Aggregate credit and external financing context
- Domestic financing:
  - Total social financing (TSF) rose by more than 50 percent of GDP between 2008 and 2013.
  - Domestic credit to firms stood at about 150 percent of GDP at end-2013, over 30 percentage points higher than in 2009.
  - Other components of domestic credit: household borrowing (about 23 percent of GDP) and LGFVs (about 25 percent of GDP).
- External financing:
  - External debt reached US$880 billion by end-2013 (about 10 percent of GDP).
  - Nearly half of total external debt is related to trade credit of short-term nature.
  - About half of foreign banks’ claims on China are on the domestic banking sector (US$353 billion out of US$698 billion in 2013).
  - Offshore bond issuance has increased substantially since 2010; China issued US$74 billion in 2013 among large emerging markets.
  - Since 2009, real estate developers have been the largest issuer of offshore bonds among nonfinancial firms.

### III. Data, scope, and classifications
- Dataset: WIND dataset of listed firms in Shanghai, Shenzhen, and Hong Kong SAR (over 2,500 firms) spanning 2003 to 2013; excludes firms classified in the financial industry; covers nonfinancial listed firms.
- Ownership classification:
  - (i) SOEs controlled by the central government (“central SOEs”);
  - (ii) SOEs controlled by the local government (“local SOEs”);
  - (iii) cooperatives;
  - (iv) group holding companies;
  - (v) private entities;
  - (vi) foreign-owned firms;
  - (vii) others.
- Industry classification: CSRC system with 13 industries; analysis focuses on nonfinancial firms.

### IV. Leverage and performance metrics (baseline patterns)
- Leverage measure: ratio of total liabilities to common equity.
- Leverage trends and concentration:
  - Private firms: median leverage fell from about 125 percent to 55 percent in 2013.
  - SOEs: median leverage has been around 110 percent of equity since 2006; leverage significantly increased at the 75th and 90th percentiles.
  - Buildup concentrated in real estate and construction, mining and utilities; local SOEs account for a large share of increased borrowing.
  - In real estate and construction, about 60 firms with high-leverage ratios account for more than two-thirds of the sector’s liabilities in 2013.
  - High-leverage firms (leverage ratio higher than three times equity) account for an increasing share of total debt and liabilities.
  - Median total outstanding loans and bonds account for 40 percent of total liabilities for firms (about 70 percent at the 90th percentile).
- Profitability and interest measures:
  - Profitability (EBIT to total assets) declined since pre-GFC; SOE profitability stable at slightly less than 5 percent after the GFC; private firms’ profitability fell to about 6 percent since 2009 from over 10 percent in 2007 peak.
  - Interest coverage ratios deteriorated to about 4‒6 times EBIT.
  - Effective interest rate rose since its low in 2009. SOEs faced lower rates between 2004 and 2009; difference disappeared after 2009.
  - Since 2008, real estate and construction sector consistently paid lower interest rates than other firms.
- Z-value: composite indicator suggests private firms’ balance sheets improved while SOEs’ deteriorated slightly in recent years.
- Regression highlights:
  - Prior to GFC, SOEs had lower leverage than private firms; since GFC, SOEs’ leverage has become much higher than private firms.
  - Firms with higher leverage face higher borrowing cost.
  - SOEs’ borrowing cost about 20 bps lower than private firms prior to GFC.
  - Post-GFC, real estate and construction sector stands out for having lower borrowing costs; wedge between private and SOE disappeared in this period.

### V. Stress definitions and scenarios
- Definitions:
  - Debt at risk: amount of loans and bonds of firms in financial distress (interest coverage ratio below one) to total loans and bonds of listed firms.
  - Financial distress: interest coverage ratio less than one.
- Baseline (2013 data):
  - Share of debt at risk about 8 percent of total loans and bonds.
  - By ownership: share highest for local SOEs.
  - By industry: debt at risk concentrated in manufacturing; real estate and construction debt at risk fairly low (0.7 percent of total debt) but sector holds about 30 percent of total listed firm debt.
- Stress scenarios:
  - Interest rate shock: 100 bps increase (moderate) and 200 bps increase (severe) applied to loans and bonds outstanding.
    - Note: liabilities other than loans and bonds (e.g., "self-raised" funding) are not captured; applying the shock to total liabilities yields larger impacts for sectors with significant non-loan liabilities.
  - Profit shock from real estate slowdown: 10 percent decline in revenue (moderate) and 20 percent decline (severe) applied to firms adjusted by sectoral linkages to real estate and construction (linkage coefficients estimated from input-output table; example: building materials coefficient 1.05; healthcare services 0.02).

### VI. Interest rate shock results
- 100 bps increase:
  - Debt at risk rises by about 2 percentage points overall.
  - Concentrated in manufacturing and transportation.
  - Share of debt at risk for local SOEs increases by 1 percentage point to more than 5 percent.
- 200 bps increase:
  - Total debt at risk could rise by nearly 5½ percentage points to reach 14 percent of total corporate debt among listed firms.
  - Central SOEs would experience the largest rise in debt at risk; central SOEs’ debt at risk would account for about half of total debt at risk in this scenario (baseline share about one-third).
  - Manufacturing and transportation account for more than 10 percentage points of the 14 percent debt at risk.
  - Real estate and construction appears less sensitive when shock applied only to loans and bonds because loans and bonds are a small share of liabilities in that sector.
  - If 200 bps shock applied to total liabilities, debt at risk for real estate and construction would rise to about one-third of total liabilities (near 10 percent of total debt at risk in corporate sector); true effect likely between the two measures.

### VII. Profit shock from real estate slowdown results
- 10 percent decline in revenue:
  - Debt at risk rises from 8 percent baseline to about 11 percent of total corporate debt.
  - SOEs account for most of the increase; total debt at risk concentrates in manufacturing because of manufacturing’s strong linkages to real estate.
  - Real estate and construction sector appears able to withstand a 10 percent decline with marginal increases in firms and debt at risk.
- 20 percent decline in revenue:
  - Debt at risk would reach nearly one-quarter of total corporate debt (about 24.6 percent reported in combined/severe scenarios).
  - Real estate and construction firms would face significant distress; median interest coverage ratio in the sector would fall to 2½ times profits.
  - 16 percent of firms in the real estate and construction sector (accounting for 11 percent of total corporate debt) would be in financial distress.
  - About 60 percent of the increase in debt at risk would belong to the real estate and construction sector.
  - Manufacturing and transportation would also be strongly affected.
  - Local SOEs would see debt at risk more than triple; about 20 percent of SOEs would be in distress (interest coverage ratio below one).
  - Some industries linked to real estate (household appliances, construction materials) face severe profit impacts — e.g., half of the firms in household appliance sector could face negative earnings and average return on assets could decline by nearly10 percentage points.

### VIII. Combined shocks (interest rate + profit shock) results
- Adding interest rate shock to profit shock:
  - Further reduces interest coverage ratios, especially at lower percentiles.
  - Does not significantly raise debt at risk beyond the profit shock alone because firms falling into distress under profit shock are often the same vulnerable to interest rate shocks.
  - Under severe combined shock scenario, sizeable fractions of firms in each sector fall into financial distress; most firms in distress are SOEs (about 15–18 percent of SOEs), particularly local SOEs with higher leverage.

### IX. Conclusions — implications and vulnerability pockets
- Aggregate and distributional facts:
  - Corporate debt increased by over 30 percent of GDP from 2009 to around 150 percent of GDP at end-2013.
  - Although average leverage for private listed firms declined, SOEs’ leverage at the tail increased, concentrated in real estate and construction, and in mining and utilities.
- Pockets of vulnerability:
  - High concentration of liabilities in a small number of highly-leveraged firms increases systemic vulnerability.
  - Real estate and construction sector concentration is critical: a 20 percent profit decline could raise debt at risk to about a quarter of total listed-firm debt.
- Sensitivities and policy-relevant insights:
  - Corporate sector is more sensitive to profit declines from a real estate slowdown than to interest rate rises alone.
  - Interest rate shocks amplify distress but marginally increase debt at risk when combined with severe profit shocks because of overlap in vulnerable firms.
  - Central SOEs would see largest rise in debt at risk from interest rate increases.
  - Local SOEs are highly exposed in real estate and would see large increases in distress under profit shocks.
  - Manufacturing and transportation are vulnerable through linkages to real estate.

*Source: IMF staff analysis in “8. Sensitivity Test Results of the Combined Interest Rate and Profit Shocks,” WIND dataset and staff estimates (2003–2013).*

### References .............................................................................................................

### _wp1572 - References .............................................................................................................

### Figures
- 1. China: Corporate Profit, Saving and Investment .................................................................15
- 2. China: Corporate Indebtedness ............................................................................................15
- 3. China: External Debt Development .....................................................................................16
- 4. China: Offshore Issuance .....................................................................................................17
- 6. China: Financial Position of Listed Firms ...........................................................................18
- 7. China: Distribution of Corporate Indebtedness Among Listed Firms .................................19
- 8. Corporate Leverage ..............................................................................................................20
- 9. Financial Performance of Listed Firms ................................................................................21
- 10. Sensitivity Analysis—Interest Rate and Profit Shocks ......................................................22

### Tables
- 1. Number of Firms in the WIND Database, by Enterprise Nature and Industries .................23
- 2. Leverage Regression ............................................................................................................23
- 3. Effective Interest Cost Regression .......................................................................................24
- 4. Interest Coverage Ratios and Financial Distress Firm
s .......................................................24
- 5. Sensitivity Test Results of the Interest Rate Shock 
.............................................................25
- 6. Sensitivity of Interest Rate Shocks on Total Debt and Total Liabilities 
..............................25
- 7. Sensitivity Test Results of the Profit Shock ........................................................................26

*Source: _wp1572 - References.*

### 8. Sensitivity Test Results of the Combined Interest Rate and Profit Shocks

### 8. Sensitivity Test Results of the Combined Interest Rate and Profit Shocks

### I. Introduction — purpose and overview
- China has increasingly relied on investment to drive growth in the post-Global Financial Crisis (GFC) period; corporate debt has significantly risen.
- Paper objective: document dynamics of corporate indebtedness using firm-level listed-firm data; assess level and distribution of debt and leverage over time, by firm type and industry; assess financial indicators and gauge leverage risk under adverse scenarios.
- Key findings:
  - While, on average, Chinese private listed firms have scaled back their leverage ratio since the global financial crisis, SOEs’ leverage at the tail end of the distribution has significantly increased.
  - The rise in leverage has largely been driven by firms in real estate and construction and in mining and utilities.
  - An increasing share of debt and liabilities is attributed to a few firms with high leverage ratios.
  - Real estate and construction firms (both private and state-owned) enjoyed lower borrowing costs after the GFC, controlling for firm characteristics, allowing them to withstand modest interest rate shocks if the shock applies only to loans and bonds.
  - Private firms in manufacturing are vulnerable to interest rate increases due to thin profit margins.
  - Central SOEs would experience the largest rise in debt at risk with an increase in interest rates.
  - A 20 percent decline in real estate and construction profit could raise total debt at risk to about a quarter of total debt of listed firms.

### II. Background — aggregate credit and external financing
- Domestic financing:
  - Total social financing (TSF) rose by more than 50 percent of GDP between 2008 and 2013.
  - Domestic credit to firms stood at about 150 percent of GDP at end-2013, over 30 percentage points higher than in 2009.
  - Other components of domestic credit: household borrowing (about 23 percent of GDP) and LGFVs (about 25 percent of GDP).
- External financing:
  - External debt reached US$880 billion by end-2013 (about 10 percent of GDP).
  - Nearly half of total external debt is related to trade credit of short-term nature.
  - About half of foreign banks’ claims on China are on the domestic banking sector (US$353 billion out of US$698 billion in 2013).
  - Offshore bond issuance has increased substantially since 2010; China issued US$74 billion in 2013 among large emerging markets.
  - Since 2009, real estate developers have been the largest issuer of offshore bonds among nonfinancial firms.

### III. Data — scope and classification
- Dataset: WIND dataset of listed firms in Shanghai, Shenzhen, and Hong Kong SAR (over 2,500 firms) spanning 2003 to 2013.
- Excludes firms classified in the financial industry; covers nonfinancial listed firms.
- Ownership classification:
  - (i) SOEs controlled by the central government (“central SOEs”);
  - (ii) SOEs controlled by the local government (“local SOEs”);
  - (iii) cooperatives;
  - (iv) group holding companies;
  - (v) private entities;
  - (vi) foreign-owned firms;
  - (vii) others.
- Industry classification: CSRC system with 13 industries; analysis focuses on nonfinancial firms.

### IV. Leverage and performance indicators — patterns and metrics
- Leverage measure: ratio of total liabilities to common equity.
- Leverage trends:
  - Private firms: median leverage fell from about 125 percent to 55 percent in 2013.
  - SOEs: median leverage has been around 110 percent of equity since 2006; leverage significantly increased at the 75th and 90th percentiles.
  - Buildup concentrated in real estate and construction, mining and utilities; local SOEs account for a large share of increased borrowing.
  - In real estate and construction, about 60 firms with high-leverage ratios account for more than two-thirds of the sector’s liabilities in 2013.
- Leverage concentration:
  - High-leverage firms (leverage ratio higher than three times equity) account for an increasing share of total debt and liabilities.
  - Median total outstanding loans and bonds account for 40 percent of total liabilities for firms (about 70 percent at the 90th percentile).
- Profitability and interest measures:
  - Profitability (EBIT to total assets) declined since pre-GFC; SOE profitability stable at slightly less than 5 percent after the GFC; private firms’ profitability fell to about 6 percent since 2009 from over 10 percent in 2007 peak.
  - Interest coverage ratios deteriorated to about 4‒6 times EBIT.
  - Effective interest rate rose since its low in 2009. SOEs faced lower rates between 2004 and 2009; difference disappeared after 2009.
  - Since 2008, real estate and construction sector consistently paid lower interest rates than other firms.
- Z-value:
  - Composite indicator suggests private firms’ balance sheets improved while SOEs’ deteriorated slightly in recent years.
- Regression results (panel regressions, random effects):
  - Prior to GFC, SOEs had lower leverage than private firms; since GFC, SOEs’ leverage has become much higher than private firms.
  - Firms with higher leverage face higher borrowing cost.
  - SOEs’ borrowing cost about 20 bps lower than private firms prior to GFC.
  - Post-GFC, real estate and construction sector stands out for having lower borrowing costs; wedge between private and SOE disappeared in this period.

### V. Sensitivity analysis — scenarios, definitions, and results
- Definitions:
  - Debt at risk: amount of loans and bonds of firms in financial distress (interest coverage ratio below one) to total loans and bonds of listed firms.
  - Financial distress: interest coverage ratio less than one.
- Baseline (2013 data):
  - Share of debt at risk about 8 percent of total loans and bonds.
  - By ownership: share highest for local SOEs.
  - By industry: debt at risk concentrated in manufacturing; real estate and construction debt at risk fairly low (0.7 percent of total debt) but sector holds about 30 percent of total listed firm debt.
- Stress scenarios examined:
  - Interest rate shock: 100 bps increase (moderate) and 200 bps increase (severe) applied to loans and bonds outstanding.
    - Note: liabilities other than loans and bonds (e.g., "self-raised" funding) are not captured; applying the shock to total liabilities yields larger impacts for sectors with significant non-loan liabilities.
  - Profit shock from real estate slowdown: 10 percent decline in revenue (moderate) and 20 percent decline (severe) applied to firms adjusted by sectoral linkages to real estate and construction (linkage coefficients estimated from input-output table; example: building materials coefficient 1.05; healthcare services 0.02).
- Interest rate shock results:
  - 100 bps increase:
    - Debt at risk rises by about 2 percentage points overall.
    - Concentrated in manufacturing and transportation.
    - Share of debt at risk for local SOEs increases by 1 percentage point to more than 5 percent.
  - 200 bps increase:
    - Total debt at risk could rise by nearly 5½ percentage points to reach 14 percent of total corporate debt among listed firms.
    - Central SOEs would experience the largest rise in debt at risk; central SOEs’ debt at risk would account for about half of total debt at risk in this scenario (baseline share about one-third).
    - Manufacturing and transportation account for more than 10 percentage points of the 14 percent debt at risk.
    - Real estate and construction appears less sensitive when shock applied only to loans and bonds because loans and bonds are a small share of liabilities in that sector.
    - If 200 bps shock applied to total liabilities, debt at risk for real estate and construction would rise to about one-third of total liabilities (near 10 percent of total debt at risk in corporate sector); true effect likely between the two measures.
- Profit shock from real estate slowdown results:
  - 10 percent decline in revenue:
    - Debt at risk rises from 8 percent baseline to about 11 percent of total corporate debt.
    - SOEs account for most of the increase; total debt at risk concentrates in manufacturing because of manufacturing’s strong linkages to real estate.
    - Real estate and construction sector appears able to withstand a 10 percent decline with marginal increases in firms and debt at risk.
  - 20 percent decline in revenue:
    - Debt at risk would reach nearly one-quarter of total corporate debt (about 24.6 percent reported in combined/severe scenarios).
    - Real estate and construction firms would face significant distress; median interest coverage ratio in the sector would fall to 2½ times profits.
    - 16 percent of firms in the real estate and construction sector (accounting for 11 percent of total corporate debt) would be in financial distress.
    - About 60 percent of the increase in debt at risk would belong to the real estate and construction sector.
    - Manufacturing and transportation would also be strongly affected.
    - Local SOEs would see debt at risk more than triple; about 20 percent of SOEs would be in distress (interest coverage ratio below one).
    - Some industries linked to real estate (household appliances, construction materials) face severe profit impacts — e.g., half of the firms in household appliance sector could face negative earnings and average return on assets could decline by nearly10 percentage points.
- Combined shocks:
  - Adding interest rate shock to profit shock further reduces interest coverage ratios, especially at lower percentiles, but does not significantly raise debt at risk beyond the profit shock alone.
  - Firms falling into distress under profit shock are often the same vulnerable to interest rate shocks, so marginal increase in debt at risk is small.
  - Under severe combined shock scenario, sizeable fractions of firms in each sector fall into financial distress; most firms in distress are SOEs (about 15–18 percent of SOEs), particularly local SOEs with higher leverage.

### VI. Conclusions — implications and vulnerability pockets
- Corporate debt increased by over 30 percent of GDP from 2009 to around 150 percent of GDP at end-2013.
- Distributional assessment matters: although average leverage for private listed firms declined, SOEs’ leverage at the tail increased, concentrated in real estate and construction, and in mining and utilities.
- Pockets of vulnerability:
  - High concentration of liabilities in a small number of highly-leveraged firms increases systemic vulnerability.
  - Real estate and construction sector concentration is critical: a 20 percent profit decline could raise debt at risk to about a quarter of total listed-firm debt.
- Sensitivities:
  - Corporate sector is more sensitive to profit declines from a real estate slowdown than to interest rate rises alone.
  - Interest rate shocks amplify distress but marginally increase debt at risk when combined with severe profit shocks because of overlap in vulnerable firms.
- Sectoral and ownership takeaways:
  - Central SOEs would see largest rise in debt at risk from interest rate increases.
  - Local SOEs are highly exposed in real estate and would see large increases in distress under profit shocks.
  - Manufacturing and transportation are vulnerable through linkages to real estate.

*Source: IMF staff analysis in “8. Sensitivity Test Results of the Combined Interest Rate and Profit Shocks,” WIND dataset and staff estimates (2003–2013).*

### REFERENCES

### _wp1572 - REFERENCES

### References cited
- International Monetary Fund, 2014, “People’s Republic of China––2014 Article IV Consultation––Staff Report,” IMF Staff Country Report No. 14/235 (Washington).
- International Monetary Fund, 2014, Regional Economic Outlook: Asia and Pacific (Washington).
- Standard and Poor’s, 2014, “Credit Shift: As Global Corporate Borrowers Seek $60 Trillion, Asia-Pacific Debt Will Overtake U.S. and Europe Combined,” Ratings Direct (New York: McGraw-Hill, June).
- Zhang, W., G. Han, and S. Chan, 2014, “How Strong Are the Linkages between Real Estate and Other Sectors in China?” HKIMR Working Paper No.11/2014. Available via the Internet:  http://ssrn.com/abstract=2441108 or http://dx.doi.org/10.2139/ssrn.2441108

*Source: _wp1572 - REFERENCES (https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp1572.pdf)*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp1572.pdf_