At 5.30pm last Friday China experienced its first bond default. It spelled the end of the ‘Beijing Put’ mentioned in WiC226 – that is to say, unlike in previous instances, there was no last-minute bailout.
In the article, WiC cited two rival arguments. One suggested that the government would continue to rescue defaulters for fear of investor panic threatening the wider financial system. The other, put forward by Fan Gang, a professor at the Peking University HSBC Business School and formerly a member of the central bank’s Monetary Policy Committee, was that Beijing was ready to allow a failure but was seeking out a “good default case”.
Fan elaborated: “They want to pick one that can teach the market a lesson but where the blame should not go to the local government. A Ponzi scheme type of case would be good. They also want the case to be containable (in terms of its contagion).”
Chaori Solar – which defaulted on interest payments last Friday – was a good candidate based on these criteria. The Rmb1 billion ($162.9 million) bond was not large enough to trigger a chain reaction and Chaori’s troubled finances were well-known (it had made losses for the previous three years). It wasn’t a Ponzi scheme but as we pointed out last year (see WiC177) the firm’s founder had got into trouble borrowing against his shares.
And in the end, the default was broadly welcomed. Analysts noted that a credit market without failures is abnormal, leading to misallocations of resources and dud investments. Rating agency Fitch called it a “long term positive”, while fund manager Zhang Zhili of Harvest Fund Management told the Wall Street Journal: “It’s a good start. Unlike a bank failure, which could really freeze up the market, this default is a small test case that could make investors more cautious when buying bonds.”
When the bond market opened on Monday morning it remained calm despite the equity, forex and commodities markets all plunging on weaker economic data. In fact the bigger moves had occurred the previous Tuesday, on the day that Chaori had indicated it would not be able to meet Friday’s Rmb89.8 million in interest payments. This saw other higher-risk corporate bonds decline in price. For example, aluminium firm Zhongfu saw one of its bonds (maturity eight years) fall 4.22%.
The timing of the default was significant too. It happened in the middle of the National People’s Congress, an annual parliamentary meeting during which the news agenda is usually stage-managed. But rather than being interpreted as negative news, the default might have been seen as corroborating a more market-led policy direction. During the NPC it was also announced that new bank licences had been awarded to private sector firms and that a new timetable was being laid out to allow banks to set their own deposit rates.
Also interesting: that Chaori is from Shanghai, a city which plans to become an international financial capital, and with a local government not keen on failures. But Shanghai might view Chaori’s default differently. By allowing it to occur, Shanghai can position itself as once again at the vanguard of reform.
The Chaori experience could lead to changes at domestic rating agencies too. According to the South China Morning Post, 96% of the ratings awarded are AA or above – clearly not a sustainable proportion now that the Beijing Put seems to have expired.
Who’s next in the queue, asked Securities Daily? A prime candidate is Sinovel, a struggling wind turbine maker (see WiC196) which has two local bonds due in 2016 amounting to Rmb2.8 billion. If, as expected, Sinovel reports a third annual loss in a row, its bonds will be suspended from trading, the newspaper posits.
Meanwhile in the offshore dim sum bond market, LDK Solar also missed a coupon repayment at the end of February.
Another question is when a trust product might default too. For now the Beijing Put seems to hold for the trust sector, perhaps because policymakers see a greater risk of contagion. But HSBC reckons that even here a default would be “manageable”. Analyst Yi Hu calculates that the majority of trusts will meet their repayments, as 84% of them are backed by governments or financial institutions.
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