TOKYO – Corporate defaults in China have reached record levels as Beijing allows companies choking on excessive debt to go bankrupt.
Chinese corporate bond issuers defaulted about 116 billion yuan ($ 18 billion) in the first six months of 2021, the highest figure for any January-June period.
Missed payments worry foreign investors and drive up the average yield on Chinese corporate bonds denominated in foreign currencies with low credit ratings to more than 10%.
President Xi Jinping’s government is prioritizing reducing excessive corporate debt. In doing so, however, it risks putting a legion of companies in difficulty to finance their activities. This could then stifle the country’s economic growth in the years to come.
Chinese companies defaulted by a record 116 billion yuan in the first half of the year, according to Shanghai DZH, an internet financial information service provider. The figure for the whole year is expected to surpass the past high, recorded in 2020, of more than 187 billion yuan and reach an all-time high.
In particular, a growing number of state-owned enterprises are failing to repay their debts, a sign of Beijing’s desire to go against the long-held assumption among state-linked borrowers and their investors according to which the government will bail them out when they get into financial trouble. For decades, state-owned enterprises have benefited from “implicit debt guarantees” from central and local governments, but they can no longer take government support for granted, according to Shinichi Seki, an economist at the Japan Research Institute.
In February, a Chinese court accepted the bankruptcy filing of travel conglomerate HNA Group under the chongzheng (reorganization) process. In March, Tianjin Airlines, jointly founded by HNA and the Tianjin Municipal Government, also embarked on the same process.
Chinese chipmaker Tsinghua Unigroup has also repeatedly defaulted on dollar-denominated bonds.
In 2019, state-owned companies made up just over 10% of all Chinese issuers that defaulted on debt. The ratio fell to almost half in 2020. State-owned companies are still responsible for around 40% of corporate bond defaults this year.
State-owned companies are going into debt “under the myth that they will never be allowed to default,” said Naoto Saito, chief researcher at the Daiwa Research Institute. But “concerns about moral hazard have led the government to embark on reform.”
A wave of large state-owned enterprise defaults signals the Chinese leadership’s commitment to breaking moral hazard by weaning debt-ridden state-owned enterprises from government protection and allowing them to go bankrupt.
The “credit boost,” which measures the growth of new financing as a percentage of gross domestic product and which is a widely observed indicator of government economic policy, is declining. The indicator generally increases when the government adopts a pro-growth policy and decreases when it decides to reduce stimulus measures. The index is sagging after peaking at 32% in November 2020. It fell to 25% in May, the lowest level since February 2020.
Foreign investors are showing signs of reducing their exposure to Chinese corporate debt. A fund manager at a foreign investment company said he would reduce the company’s investment in bonds of low-credit Chinese companies.
Yields on so-called high-yield corporate bonds, which are rated below investment grade, are on the rise. Chinese dollar-denominated high-yield bonds returned 10.1% per annum on average on June 15, posting a reading above 10% for the first time in about 13 months, according to the Intercontinental Exchange. This contrasts sharply with the global average yield of less than 5% for these speculative grade bonds.
Some state-owned enterprises have also been affected by credit downgrades by rating companies. The credit ratings of Chinese real estate giant China Evergrande Group were downgraded by Fitch Ratings and Moody’s Investor Service in June. These moves have pushed the company’s bond yields above 20% regardless of their maturity dates.
The wave of state-owned enterprise failures is also hurting the solvency of private sector enterprises. Chinese retailer Suning.com, which caught the world’s attention in 2016 when it acquired Italy’s Serie A leaders Inter Milan, has been one of the notable victims of the trend.
The company’s financial health has deteriorated due to reckless expansion in recent years. Investors are increasingly worried about its ability to repay its debt.
Chinese companies will face major tests of their financial health over the next two years, with $ 2.14 trillion in bonds maturing by 2023, 60% more than the value of maturing bonds from 2018 to 2020.
The Xi government seeks to eliminate state-owned enterprises burdened with excessive debt without causing serious turmoil in financial markets through managed debt restructuring.
But investors have responded to the campaign by rushing out of junk bonds. If this causes a credit crunch for a large number of Chinese companies, the country’s economy could take a hard hit, derailing Beijing’s strategy for a soft landing.
“If a sharp rise in corporate bond defaults leads to a further rise in bond yields and other broader market spillovers, the Chinese government will start providing direct and indirect support (to heavily indebted state-owned enterprises) “Saito of Daiwa predicted.
Koichi Fujishiro, chief economist at the Dai-ichi Life Research Institute, warned that a slowdown in investment growth in China could dampen global exports to the huge market and make a big dent in global economic growth.