Bond defaults signal moment of truth for China ratings agencies, banks
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 US$ 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 two billion yuan ( US$ 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 AArated 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 state- owned enterprises ( 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.” — Reuters