Chinese debt defaults send investors into a tizzy
Despite claims of an economic recovery, Chinese state-owned companies are defaulting on their debts. A string of missed debt repayments by major firms has shaken local as well as global markets. State firms defaulted on a record $6.1 billion worth of bonds between January and October, according to Fitch Ratings. That’s about as much as the last two years combined. The development has rattled China’s nearly $4 trillion corporate debt market, of which state-owned enterprises are estimated to account for more than half. At least 20 firms suspended plans for new debt issues totalling $2.4 billion, all citing recent market turmoil.
The mounting non-payment of debt payments is getting worse in recent weeks. A slew of major companies, including German automaker BMW’s Chinese partner Brilliance Auto Group, top smartphone chipmaker Tsinghua Unigroup, and Yongcheng Coal and Electricity declared bankruptcy or defaulted on their loans in November. This was enough to send shock waves through debt market. Bond prices nosedived sharply, interest rates soared and the turmoil even spilt over into the stock market, with shares of state-owned firms plummeting.
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The defaults have angered global investors, who say their faith in the firms’ top-notch ratings, seemingly sound finances and implicit state backing has been violated. There is a panic among investors who believed that the close relationships between these companies and Chinese governments make them safe bets in times of trouble. But investors are a worried lot as the state is no longer willing to support these companies; investments have suddenly become much riskier propositions.
“The credibility of government guarantees has been the most important bulwark against financial crisis so far. Now we are seeing signs that this credibility is eroding,” according to Logan Wright, director of China markets research at Rhodium Group, CNN reported.
According to Reuters, the Huachen Automotive Group Holdings Co, the parent of German automaker BMW’s Chinese joint venture partner, defaulted late last month exemplifying opaque risks, underdeveloped pricing mechanisms and investor naivety in China’s corporate bond market. “If the company had told investors it was in great trouble, I wouldn’t have bought and held the bonds,” said Shanghai-based hedge fund manager Vincent Jin, who bought Huachen bonds early this year. Huachen boasted an AAA issuer rating when it launched its 1 billion yuan ($151.93 million) three-year, privately placed bond in October 2017. It comes from one of China’s poorer provinces, Liaoning, but as recently as April told bondholders it had adequate cash, lots of land and state backing. Creditors were therefore stunned when Huachen not only defaulted but was also dragged to court by a creditor for bankruptcy restructuring. Moreover, one month before its bond delinquency, Huachen transferred its prized 30 per cent stake in Hong Kong-listed Brilliance China Automotive Holdings Ltd to a subsidiary, leaving bondholders with no access to those assets.
Chinese companies have been piling on debt for at least a decade, ever since the government responded to the 2008 crisis by going on a borrowing binge. That kept China’s economy moving but at a cost. The corporate debt-to-GDP ratio surged to a record 160 per cent at the end of 2017, from 101 per cent 10 years earlier. The present dispensation under Xi Jinping tried to rein it in, issuing directives on how money was to be loaned and managed. A particular goal has been to curb China’s $10 trillion ecosystems of shadow banking. So-called local government financing vehicles, which were established to fund infrastructure projects, have already defaulted on many trust loans which were part of that shadow system.
China watchers say allowing too many defaults could jeopardise the financial stability and near-term recovery. Analysts at Goldman Sachs recently pointed out that widespread failures in the sector could spill over into the banking system, causing banks to cut back on lending more broadly, or increase interest rates, the latter of which is already starting to happen. But, analysts have also noted that rescuing some state-owned firms from collapse is probably a dead end, given how financially cumbersome the sector can be.