Commentary on Political Economy

Friday 13 December 2019

China hit by biggest dollar bond default by state company in two decades
 Analysts expect further failures as local governments remove support 

China’s Tewoo Group has forced investors to take losses on a US dollar bond, marking the largest failure to repay dollar debt by a state-owned company in two decades and provoking fears of a wave of defaults. The commodities trader, which is wholly owned by the city government of Tianjin, completed an exchange offer this week that made investors take significant discounts on their holdings in the company’s debt. The offer was “tantamount to a default”, S&P Global Ratings said on Thursday, and is expected to reframe how global investors view the market for government-backed corporate debt. “The market has been building to something like this,” said Fraser Howie, an independent analyst and co-author of the book Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise. State-owned enterprises “cannot be assumed to be backed by the state when it comes to bond repayment”, he added. 

Until this year, no Chinese company backed by the state had been allowed to default on its dollar debt since the collapse of Guangdong International Trust and Investment Company, or Gitic, in 1998. A missed payment on a US dollar bond in February by Qinghai Provincial Investment Group signalled that state support was waning, although the company made the payment within a five-day grace period. Tewoo’s restructuring represents a radical shift in how the Chinese government deals with failures at debt-strapped state enterprises by forcing investors to take losses. The restructuring offer, which has been accepted by investors, gave Tewoo bondholders two options. The first was to take deep discounts on four outstanding bonds — one of which, a $300m bond, matures on Monday. The other option was to exchange the Tewoo bonds for that of another Tianjin-based state enterprise and accept far lower coupons.

 Given the economic downturn in China, the Chinese government may lack the resources to bail out all defaulting companies and will probably be forced to accept more market-based restructurings, global investors have warned. “We expect the government to be more selective in where it uses its resources,” said Alaa Bushehri, head of emerging markets corporate debt at BNP Paribas Asset Management in London. “It doesn’t do anyone any good to be in that comfort zone.” Gitic’s default in 1998 sent a shockwave through Asia’s US dollar debt market as investors were forced to recalibrate anticipated state support for government-owned companies. But the collapse of the company came at a time when the borrowings of Chinese state-owned enterprises were still small. Today, state groups are some of the largest debt issuers in Asia, and Beijing is wary that an end to the state’s implicit guarantee will force a repricing of risk associated with such companies and drive up borrowing costs. Some analysts expect that Tewoo’s problems, and the lack of support from the city government in Tianjin, are just the beginning of a series of defaults at government-backed groups. “We believe Tianjin is not an exception and other local governments with deteriorating fiscal profiles might also see eroding support for their uncompetitive and distressed SOEs,” S&P said on Thursday.

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