Obtain the data you need to make the most informed decisions by accessing our extensive portfolio of information, analytics, and expertise. Sign in to the product or service center of your choice.
Between October and December 2020, three companies were involved
in high-profile, unexpected bond defaults in mainland China:
Yongcheng Coal and Electricity, a state-owned energy company that
defaulted on a CNY1-billion (USD152.7 million) bond; Tsinghua
Unigroup, a computer chip maker majority-owned by Tsinghua
University, which defaulted on a CNY1.3-billion bond and a
USD450-million bond after failing to roll over its debt; and the
owner of Brilliance Auto, state-owned Huachen Automotive Group,
which failed to pay a CNY1-billion bond and later entered
bankruptcy restructuring.
Mainland China has a history of bond defaults but bank
restructuring has indicated wider financial stress.
The recent high-profile defaults by the three SOEs have totaled
about CNY6.3 billion so far. This is a small proportion of total
corporate bond issuance so far in 2020 (as of the end of November,
this is equivalent to 1.7% of CNY363.5 billion), according to IHS
Markit's calculations using China Bond data. Moreover, the latest
failures are not particularly large when compared with SOEs'
previous defaults. In the second half of 2018, five SOEs filed for
bankruptcy with total liabilities of CNY9.9 billion, the largest
default of which was CNY5.8 billion. The recent events are
important considering their impact on the prior perception of
implicit guarantees for SOEs, and because they involve enterprises
active in areas perceived as strategically key, including computer
chips and the automotive sector, rather than involving highly
indebted conglomerates or real estate companies. Apart from bond
defaults, bank failures also increase investor concerns, with
Baoshang Bank, a local bank based in Inner Mongolia, becoming the
first commercial lender in mainland China to file for bankruptcy in
two decades. Local media reported that in 2020 alone, as of August,
there had been more than 20 mergers and reorganizations involving
small and medium-sized regional banks seeking to consolidate
capital. A move to tighter regulatory scrutiny and efforts to
encourage increased investor focus on risk were also flagged by the
recent high-profile withdrawal of Ant Group's initial public
offering (IPO) in Shanghai and Hong Kong on regulatory grounds
after achieving a global record for potential share issuance with
massive oversubscription, and also by the withdrawal of a planned
blockchain-based bond for China Construction Bank's Malaysian
branch.
Mainland China's central government has flagged concerns
about the accumulation of debt leading to systematic financial
risks, which aims to prepare markets for defaults.
Former finance minister Lou Jiwei highlighted in November that
mainland China needs to "investigate an orderly withdrawal from
loose monetary policy" because of its debt pressure but fast
withdrawal is unlikely to avoid triggering a debt crisis,
indicating continued fiscal expansionary policy in 2021 but
involving smaller scale adjustments. Vice-Premier Liu He noted that
recent increase in default cases was a result of "cyclical,
institutional but also behavioral factors", including fraud, false
information disclosure, inappropriate transfer of assets, and
misappropriation of issue proceeds. Premier Li Keqiang during his
meeting with officials from Guangdong, Heilongjiang, Hunan, Yunnan,
and Shandong (which, combined, represents around one-quarter of
mainland China's economy), had asked the officials to "honestly
report the economic situation, plans for the next economic period,
and their opinions on mainland China's macroeconomic policies". The
PBoC also join this view. PBoC Governor Yi Gang emphasized the
issue of insufficient supervision in systemic financial risks and
highlighted that local governments and financial institutions have
pressured the central government and the PBoC to bear the costs of
resolving financial stresses. The article proposed holding
financial institutions, local governments, and financial regulatory
authorities responsible for future deterioration in financial
risks.
Defaults show a delayed response to economic slowdown,
while policy measures have delayed corporate failure.
The latest defaults occurred in the third quarter of 2020 after
the domestic economy recovered, instead of during the sharp
economic recession in the first quarter. They are likely to reflect
a lagged reaction to economic slowdown, initially mitigated by
policy measures supporting the corporate sector, including easier
monetary policy that permitted stressed firms to access external
funding at a lower cost. Poor profitability is another factor
behind SOEs' defaults. The National Bureau of Statistics has
reported that industrial profit growth of SOEs has lagged that of
the private sector since the beginning of 2019. The year-to-date
industrial profits of the private sector returned to a positive
level in October, while that of SOE remained 7.5% down on a
year-on-year basis.
Local SOE defaults have wider repercussion for the
region.
After local SOE Qinghai Yanhu defaulted in 2019, Qinghai
province's new total social financing (TSF) declined from CNY128
billion in 2019 to only CNY45 billion through September this year,
compared with a 15% increase nationwide during this period. In
addition, credit spreads for borrowers in the region rose sharply
by 20% after the default, while those on local government financing
vehicle bonds rose by over 60%. Moreover, the proportion of loans
applying rate above the benchmark loan rate has increased from less
than 35% to 60% in Qinghai (guiding the central bank's announced
interest rate for commercial bank loans). As a result, the region
has become increasingly reliant on government funding, with 80% of
its 2020 TSF coming from local authority bonds. The default also
impacted on economic growth, prior to the default, Qinghai had been
outperforming national level growth. However, after the default in
2019, Qinghai's fixed asset investment dropped significantly,
recording a 5.2% year-on-year (y/y) contraction in the first 10
months of 2020, versus 1.8% y/y expansion nationwide. As a result,
Qinghai's real GDP growth fell below the national average for most
quarters since 2019. All of this didn't improve debt burden, with
industrial firms' liability-to-asset ratio in Qinghai rising from
68% at the beginning of 2019 to 73% after the default.
The banking sector's bond investment is a significant
portion of banking-sector assets, recent defaults likely pushes
some towards lending to MSMEs.
According to IHS Markit's calculations using China Bond and
CBIRC data, banks' investment in bonds accounted for around 19% of
total banking-sector assets in the third quarter of 2020, versus
56% of total banking-sector assets in the form of bank loans. The
latest data show that investment in bonds has risen by 17.1% y/y,
compared with 13.3% in November 2019, and has exceeded the loan
growth rate of around 13% y/y, signaling an increased proportion of
assets being held as bonds. However, most of the growth has
concentrated in government bonds, with investments in corporate
bonds more or less flat between November 2019 and 2020. Although
even before COVID-19, the Chinese authorities have been encouraging
banks to lend more to MSMEs to rebalance the sector's lending away
from housing and traditional corporate lending, the Chinese
authorities have stepped up their efforts to encourage MSME lending
by reducing the loan prime rate and the reserve requirement ratio.
It is likely that some of the funds previously used to purchase
corporate bonds had been diverted to MSME lending, and the recent
bond defaults provide banks with more reason to further increase
lending in this direction. However, despite the fact that lending
to micro and small enterprises has
risen at a faster rate than bond investment in mainland China, at
30% in 2020, lending to MSEs is unlikely to replace bond
investments in the next two years due to outstanding lending to
MSEs stood at over 5% of total assets in the third quarter of 2020,
compared with 19% of total assets for bonds.
Chinese authorities have been working to reduce moral
hazard related to investments.
The authorities have previously warned that smaller state-owned
banks will be allowed to fail and have demanded that banks do not
guarantee the repayment of principal on shadow bank investments for
retail customers. The reaction to recent developments - such as
approving the bankruptcy of Baoshang Bank - appears consistent with
these principles. The domestic reaction - notably the investor
"surprise" over SOE failures - highlights that moral hazard and a
misconceived perception of implicit state support for SOE debt
remain problematic. The worldwide economic impact of COVID-19
provides a useful background to change this view, with the
government likely to attribute blame for further state-owned
companies' failure on global economic factors; further defaults
should give additional encouragement to investors to rethink their
strategies.
Wider SOE defaults are likely, with both central and
local governments expanding the scope for companies to default
without state intervention, affecting both private-sector firms and
smaller state-owned companies and financial
institutions.
Increasing tolerance for defaults and bankruptcies are
consistent with the administration's policy stance under President
Xi Jinping's long-term plan to increase the efficiency of
state-owned companies, but this is far from new. The 2015 "Guiding
Opinions on Deepening the Reform of State-owned Enterprises"
highlighted the need for state companies to become "market-driven
entities which manage their own profits, losses, and risk-taking
behavior". Nevertheless, to avoid major local dislocations or
damage to overall economic recovery, the government is, in our
view, still highly likely to intervene to support strategically
important state-owned companies and prevent defaults that would
trigger localized financial stress events. This approach will leave
local-level, small-scale state companies with cash flow and
financial difficulties less likely to gain local government
financial support, particularity for firms not directly controlled
by government entities. Additionally, wider defaults in assets
previously considered to enjoy state backing is likely to damage
investor confidence gradually, in turn making it more difficult for
local governments and SOEs to obtain new financing.
Posted 28 December 2020 by Angus Lam, Senior Economist, Country Risk, IHS Markit and
David Li, Principal Asia Analyst, Economics & Country Risk, IHS Markit and