A man counting 100 renminbi banknotes, the Chinese currency.
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SINGAPORE — A series of high-profile defaults involving state-owned companies in China — normally a safe bet for investors — rattled the credit market and rattled investors, sending the bond market sold off last week.
As the hemorrhage continues to point to more bond defaults to come, observers debate why more state-owned enterprises (PEs) are being left behind this time around compared to the past two decades and what segments of the market, if any, the government chooses to support.
State mining company Yongcheng Coal and Electricity defaulted on a 1 billion yuan ($151.9 million) bond last week, triggering an expanded state investigation into three underwriting banks suspected of misconduct.
Other high-profile defaults followed suit this week, including government-backed chipmaker Tsinghua Unigroup, which missed payment after failing to extend its repayment deadline, and another default by the company. State Huachen Automotive Group – a Chinese joint venture partner of BMW. Last month, one of China’s largest property developers China Evergrande was also honored for apparently having cash flow problems.
“The [Yongcheng] The default has raised concerns among investors about the broader corporate bond market, as it breaks the long-held assumption of an implicit government guarantee for state-owned enterprise bonds,” wrote Zhaopeng Xing, Chinese markets economist at ANZ Research, in a note on Friday. SOEs are well below 1% currently, compared to the default rate of 9% for private companies, according to ANZ data.
Payment defaults by government-backed companies in China were rare before lately. In late December last year, the case of a dollar bond default by commodity trader Tewoo Group was the first in two decades.
More defaults come as Chinese authorities refocus on deleveraging state-owned enterprises now that the worst of the pandemic is over.
S&P Global Ratings
The defaults come even as many asset managers, bullish on Chinese debt, have pushed calls for investments in Chinese bonds this year. They offer a very attractive proposition for investors with their yields – far superior to US or European yields – in a world where it is increasingly hard to find.
China’s onshore bond market is worth $13 trillion, the second largest in the world.
So far this year, investors have outpaced them. Foreign inflows into onshore China bonds via funds hit an annual high of $21.43 billion in March, up from $9.5 billion at the end of last year, according to Refinitiv data. The iShares Barclays USD Asia High Yield bond is up more than 31% since a low in March.
Here’s what analysts believe are some of the factors at play in the recent spate of defaults involving Chinese state-owned companies.
Chinese government may be more willing to accept defaults as economy recovers from pandemic – coupled with its drive to reduce debt in the economy, S&P Global Ratings said in a note Tuesday.
“Further defaults come as Chinese authorities refocus on deleveraging state-owned enterprises now that the worst of the pandemic has passed,” said Chang Li, China specialist at S&P Global Ratings.
Beijing was in the process of deleveraging with soaring debt in the country, but held back as the pandemic hit businesses. Instead, the authorities encouraged banks to provide more loans to small and medium-sized enterprises. But now debt is rising again as the pandemic puts pressure on businesses, leading authorities to refocus on reducing debt levels.
“In our view, the selling, which was more pronounced for domestic bonds than for foreign bonds, reflects the potential willingness to allow even large state-owned enterprises to default,” the note added.
The market may see this as a signal that deleveraging and reform of state-owned enterprises will accelerate as the economy recovers from the pandemic.
S&P Global Ratings
S&P pointed to the example of state mining company Yongcheng Coal and Electricity – which missed its bond payment which was due on November 10. This could lead to a cross-default of its parent company Henan Energy and Chemical Industry, one of the largest state-owned companies. belonging to companies in Henan province, he added. Together, that puts 50 billion yuan ($7.6 billion) at risk of default, according to the ratings firm.
S&P pointed to the “seemingly abrupt removal of government support” in the case of the coal miner. Just a month before it defaulted, the ratings firm said Yongcheng was expected to swap loss-making chemical companies for profitable coal companies. Moreover, it had just issued a 1 billion yuan medium-term note in October.
These actions were taken together as “signs of government support”, according to S&P.
“In our vision, [Yongcheng]surprised the market as it indicated that the attitude of the local government to provide support had reversed in just one month,” Li said. will accelerate as the economy recovers from the pandemic.”
Opportunity to eliminate the bad?
The Chinese government has allowed some of the companies “with very weak credit matrices to fail without bailouts,” said Tan Min Lan, chief investment office manager for Asia-Pacific at UBS Global Wealth Management.
But that’s actually a positive, she said, suggesting it allows for some “differentiation” in the Chinese market between stronger and weaker companies.
“We have been saying for some time now that the increase in credit differentiation is actually a positive for the long-term development of the Chinese market. Now, if you relax 2 years ago, there is no no differentiation because there is no defect,” she said. CNBC’s “Squawk Box Asia” on Wednesday.
The pandemic strains financial resources
The coronavirus pandemic has strained public resources as the government launched stimulus measures to support businesses amid the fallout.
The impact is probably being felt now.
“The pandemic and increasingly stringent regulations from central authorities could limit the power of local governments to coordinate financial resources, and even the willingness to provide support,” S&P Global Ratings said.