International banking firm Goldman Sachs warned that China\s corporate debt could balloon significantly with the continuing presence of "zombie companies".
In a note given to investors on July 12, Goldman analyst Hui Shan said that as much as 10 percent of the credit that has entered so-called "zombie companies" in 2015 may have been used to pay just the interest on their standing debts, Business Insider reported.
A zombie company is a company that is capable of repaying only the interest of its debts but not the principal.
The analyst noted that these companies have been increasingly been allocating a larger portion of their incomes to servicing existing debt, with the debt servicing ratio going from 12 percent to 20 percent in the last couple of years.
Shan then said that the situation China is facing now can be likened to a Ponzi scheme where the companies will ultimately not be able to pay back their standing debts. She added that a similar situation has already occurred in both the United States and the United Kingdom when the collapse of mortgage-backed bonds triggered the 2008 global recession.
According to Shan, the effects of the current debt situation in the economy can now be clearly seen in the country's steel market.
For instance, when the government allowed Liaoning Province-based Dongbei Special Steel Group to issue bond payments for its $6 billion outstanding debt, it was hoped that it will encourage the company to resolve the issue. However, the company ended up missing five consecutive payments, worsening its situation.
However, experts said that as many of these state-owned companies are based in the provinces, their respective local governments are reportedly meddling with the decisions of lenders on which gets financing. This, in turn, makes it harder to eliminate zombie companies, The Australian reported.
Analysts said that the problem is likely to drag on for several years. However, Bernhard Kotanko of consultancy firm Oliver Wyman is confident that China will eventually be able to resolve it. "They will find ways to smooth it out over time," he said.