Chinese state-owned defaults could seriously slow economic recovery
Chinese state-owned companies are starting to default on their debts. This is a problem that could break through the country’s financial system, threatening to hit the national economy and slow down its recovery from the pandemic..
Default volume between January and October totaled 40 billion yuan, Fitch Ratings reports. This is about the same as in the last two years.
Many large companies including Chinese partner BMW Brilliance Auto Group, a leading smartphone chip maker Tsinghua Unigroup and Yongcheng Coal and Electricity filed for bankruptcy or default on their loans last month, shocking the country’s debt market. Bond prices plummeted, interest rates jumped, hitting stock markets and bringing down state-owned securities.
This gives several reasons for concern at once.. First of all, the close relationship between companies and the Chinese government usually makes their assets a safe investment in times of trouble.. If investors see that support has ended, state-owned stocks will become less attractive.
Second, the success of the public sector is critical to China’s financial system.. Although these firms account for less than a third of GDP, they account for more than half of bank loans and about 90% of corporate bonds, according to the People’s Bank of China..
«Trust in government guarantees has been the most important bulwark against the financial crisis so far. Now we see signs that their authority is undermined.», – He speaks Logan Wright, Director of Research, Chinese Markets, Rhodium Group.
Historically, Beijing did not want these companies to fail.. The Chinese Communist Party has tight control over wide areas of the economy, including business, and it believes the ties between these businesses and the government are important.
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Now they seem ready to let at least some of the market participants go to the bottom.. But too many defaults would make the financial system incredibly vulnerable, which is fraught with high risks..
If Beijing’s ability to manage debt is questioned, Wright believes it could stress the financial market by cutting available credit and liquidity.. The consequences are already being felt. Bond Funding Drops In November.
These challenges could ultimately delay the fragile recovery of the world’s second largest economy. The International Monetary Fund expects China’s economy will grow by 1.9% this year, which will be better than its global counterparts.
«Attempts to dominate risky borrowing will put pressure on the pace of non-bank lending. While this will not hinder China’s economic recovery overnight, it will gradually weaken political stimulus efforts.», – wrote Julian Evans-Pritchard, Senior Economist, China Capital Economics, having in mind the steps of the government this year to cut interest rates and billions of dollars in spending to support GDP growth.
While the record number of bond defaults is likely largely due to the coronavirus pandemic, China’s state-owned enterprises have been piling up debt for years..
The Chinese government is supporting the sector with trillions of dollars in since the 2008 global financial crisis, but these investments did not bring the expected results.
The disadvantages of public business are widely recognized. Such firms are often less competitive than their private counterparts and generate lower financial returns, said Ning Gaoning, Chairman of the State Chemical Conglomerate Sinochem Group.
State-owned companies accounted for the lion’s share of credit bond issues in the first nine months of the year. Such firms have raised about 8.5 trillion yuan, compared with 857 billion yuan from the private sector ($ 131.2 billion), according to the Chinese rating agency Pengyuan International..
Beijing is taking some steps to help calm the market. Last month, the People’s Bank of China launched one trillion yuan ($ 153 billion) in loans to ease liquidity pressures and calm investor nerves..
Vice Prime Minister Liu He, chairing China’s financial stability committee, also trying to boost confidence. During a recent meeting with financial and economic officials, he urged local governments to prevent worst-case scenarios by strengthening the systems and mechanisms they use to identify systemic risks and maintain adequate liquidity..
In doing so, he also warned state-owned companies that Beijing does not intend to fix «strategic defaults». Authorities believe some companies are deliberately evading debt obligations.
Analysts also noted that bailing out some state-owned companies from collapse is likely a dead end given how financially burdensome the sector can be.. Along with their other disadvantages, for example, such companies use only 10% of the workforce.
However, growth too many defaults could jeopardize financial stability and short-term recovery. Goldman Sachs analysts recently noted that widespread sector disruptions could spill over to the banking system, forcing banks to cut lending on a wider scale or increase interest rates.