Despite being ground zero for the coronavirus pandemic, China will be one of only a few major economies to record growth this year. Its billions in fiscal and monetary stimulus and relief allowed the nation to recover rather quickly from the COVID-19 public health crisis. But Beijing’s past interventions – from 2020 and before – may be coming back to haunt the world’s second-largest economy as a growing number of state-owned enterprises (SOEs) are falling like pieces on a Mahjong table board. It might be time to get drunk on baiju and play ping pong because it is going to be messy like a dinner plate of General Tso’s chicken.
A Bond Default Made in China
Yongcheng Coal & Electricity Holding Group, a state-owned mine operator in the Henan province, did not make a principal or interest payment on AAA-rated commercial paper worth $151.8 million. The missed payment initiated panic selling, crashing bond prices by as much as 93%. Investors also sat on the sidelines and did not acquire any of Yongcheng Coal’s outstanding bonds, suggesting that they think the state-owned enterprise will fail to repay its debts.
What makes this both a compelling and concerning development in Beijing is that other high-profile SOEs and companies with strong ties to the central government are also defaulting on their domestic notes. Tsinghua Unigroup, a top chipmaker, announced that it would not be able to repay a $197 million privately-issued onshore bond. Brilliance Auto Group Holdings Co., an automaker with connections to BMW, confirmed that it had defaulted on a $987 million debt.
Market observers are bracing for more SOE defaults over the next several months. One of the reasons is because government-owned entities are tapping the corporate bond market to raise cash. Fitch Ratings estimates that SOEs with weak credit profiles have approximately $100 billion worth of bonds that are set to mature this year.
But why did none of the rating experts see what was coming? Was it ignorance or intentional? Indeed, domestic credit rating agencies that assess risk had ostensibly fallen asleep at the wheel. In the days and weeks leading up to these firms’ defaults, none of the organizations sounded the alarm with warnings or downgrades.
This year, there have been more than 100 corporate bond defaults, totaling approximately $20 billion. While the figure is down from the 184 defaults that occurred in 2019, it is noteworthy that prominent SOEs face this level of difficulty and are creating the most consternation. It is also troubling for local governments because these defaults are now costing municipalities more to borrow since they cannot guarantee their bonds. Overall, the years of piling up debt are taking a toll on the bond market.
Investment houses are now shrieking to the heavens about being exposed to these risky assets. Not too many foreign investors are listening since they are convinced that the government will intervene with good old-fashioned bailouts of these organizations.
CreditSights, a research firm, wrote in a research note:
“Market participants have once again been reminded that not all state-owned enterprises (SOEs) are created the same; some are less equal than others.
As the spate of defaults has shown, support conferred by state ownership is more nuanced and the Chinese government on balance is more tolerant of defaults. SOEs which are not in strategically important industries or have strayed from their core businesses may not be rescued by the state.”
Rise of the Zombies
In a recent financial stability report, the People’s Bank of China (PBoC) identified a chief threat to the national economy: Zombies. According to the central bank, these zombie firms rely on debt accumulation to grow their companies and then on perpetual borrowing to make debt repayments.
Liberty Nation has reported on China’s problem with too many of these zombie companies – both public and private. As part of the nation’s market-oriented reforms, President Xi Jinping has stated that his Communist government plans to allow more SOEs to fail without state intervention. It is unclear if Xi would follow through on his pledge amid a post-coronavirus recovery.
In theory, this would be a positive move since it would free up resources, facilitate economic dynamism, and provide value to the real economy. Overall, the fall of zombies would be a positive development for the country’s long-term financial health. But would Xi permit short-term pain for long-term gain? Beijing is set to unveil its next socialist prototypical five-year plan, so it is safe to say that it has an abundance of time until a vaccine is needed to treat the zombie infection.
In the meantime, the PBoC will soothe market jitters by injecting it with a fresh dose of liquidity. On November 24, the central bank pumped more than $120 billion into the financial system to ensure ample liquidity. However, this type of intervention will only prevent the bond market from pricing in these credit risks and sending signals to the broader market.
And this type of neo-Keynesian orthodoxy is why China and other nations will endure a debt crisis.
The Fall of China?
For years, China has depended on debt to survive and thrive in the global economy. Many of the nation’s bubbles had been rooted in red ink, only to cause severe hemorrhaging later. From the collapse of the housing bubble to the popping – and reinflating – of the stock market, China’s toxic concoction of money-printing and debt will only exacerbate its inevitable fall. The country is rebounding at a commendable pace in nearly every metric, but its growth was only achieved through an aggressive Made in China quantitative easing approach. Once the pandemic winds down, Beijing will discover the ghosts of its past. The Ponzi scheme of debt on debt to pay for old debt will crush the economy faster than you can say Bernie Madoff or Social Security.
Read more from Andrew Moran.
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