China over­com­ing re­luc­tance to al­low bond de­faults

Kuwait Times - - BUSINESS -

SHANG­HAI/HONG KONG: China looks set to al­low more bond de­faults as part of its mar­ket re­form agenda, but do­mes­tic rat­ings agen­cies and bond in­vestors are still bet­ting Beijing will lose its nerve, for fear of ham­mer­ing its banks. Crit­ics say the $4 tril­lion Chi­nese bond mar­ket, the world’s third largest, has mis­al­lo­cated its vast sums to some of China’s most in­ef­fi­cient com­pa­nies, such as state-owned di­nosaurs in sun­set in­dus­tries or opaque lo­cal gov­ern­ment fi­nanc­ing ve­hi­cles.

The mar­ket’s as­sump­tion that such is­suers have an un­writ­ten state guar­an­tee has kept bond yields low, while de­mand among in­vestors is high, es­pe­cially af­ter a sum­mer stock mar­ket crash sent many flee­ing to rel­a­tive safety. “China is still ex­pe­ri­enc­ing an on­shore debt boom,” said Mervyn Teo, credit an­a­lyst with Lu­cror An­a­lyt­ics, but he be­lieves re­cent de­faults ar­gue for more cau­tion.

As re­cently as Thurs­day, China Shan­shui Ce­ment de­faulted on a 2 bil­lion yuan ($300 mil­lion) on­shore debt pay­ment, and in April Baod­ing Tian­wei Bao­bian Elec­tric be­came the first sta­te­owned firm to de­fault, while an­other, met­als trader Si­nos­teel, de­ferred in­ter­est pay­ments last month.

All of which sug­gests Chi­nese au­thor­i­ties, which used to work fever­ishly to pre­vent de­faults, are grow­ing more will­ing to let weak firms fail.

De­spite such de­faults, the spread be­tween bench­mark yields on safe AAA-rated bonds and riskier AA-rated bonds has fallen sharply in re­cent months, in­di­cat­ing that peo­ple see them as less, not more, risky. In­deed, it has been de­clin­ing grad­u­ally all year, as in­vestors have in­stead as­sumed that gov­ern­ment con­cern about slow­ing growth will make them less will­ing to let mar­ket dis­ci­pline run its course, es­pe­cially in the state sec­tor.

“In the past there were no de­faults, be­cause al­most all is­suers were SOEs or gov­ern­ment backed,” said Phillip Li, man­ag­ing di­rec­tor at China Chengxin Asia Pa­cific Credit Rat­ings.

“This can­not con­tinue. In or­der for the debt mar­ket to be nor­mal, un­healthy debt should be iden­ti­fied.”

AGENTS OF BOOM

Do­mes­tic debt rat­ing agen­cies ought to per­form that func­tion, but in­dus­try in­sid­ers say they are in­stead en­gag­ing in a price war for clients, in many cases offering op­ti­mistic rat­ings in ex­change for the con­tract.

Their rat­ings cer­tainly paint a rosier pic­ture of lo­cal firms than their for­eign coun­ter­parts’.

The lo­cal agen­cies say their rat­ings take into ac­count the fact of reg­u­lar gov­ern­ment in­ter­ven­tion, an un­writ­ten as­sump­tion that for­eign ri­vals are less likely to rely upon.

But at the bot­tom of the heap, dis­tressed debts all smell equally bad, says Kalai Pil­lay, Fitch Rat­ings di­rec­tor in Sin­ga­pore, so their do­mes­tic and for­eign rat­ings ought to con­verge but don’t.

“A ‘D’ is a ‘D’ - there is no am­bi­gu­ity,” he said.

Pol­i­cy­mak­ers in Beijing are faced with a sticky dilemma. Let more of its in­dus­trial di­nosaurs go ex­tinct, prompt­ing the lo­cal agen­cies to down­grade the bonds of com­pa­nies like them, which in turn could trig­ger a cri­sis for China’s banks, by far the big­gest bond­hold­ers.

Or let an un­re­formed bond mar­ket con­tinue to set ar­ti­fi­cially low yields and throw good money af­ter bad, which ex­ac­er­bates China’s in­dus­trial over­ca­pac­ity and in­creases the like­li­hood of fall­ing prices and eco­nomic stag­na­tion.

“Avoid­ing a cri­sis and the spread of sys­temic risk is al­ways the num­ber one pri­or­ity of the gov­ern­ment,” said Oliver Bar­ron, pol­icy re­search an­a­lyst at China-fo­cused in­vest­ment bank NSBO.

“This means that some com­pa­nies that shouldn’t be bailed out will be, per­pet­u­at­ing the cur­rent moral haz­ard and lead­ing to wasted cap­i­tal,” he said. — Reuters

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