Commentary on Political Economy

Monday 5 July 2021


Here’s where the cracks are starting to show.

China’s corporate credit market is the world’s biggest, after the U.S.

It’s also one of the safest. The government has backstopped even the most reckless companies, fending off defaults where they were arguably long overdue.

But those days are now drawing to a close as Beijing forces more accountability on its weakest companies to reduce moral hazard. The defaults are coming.

In China, the current default rate is around 1%; in more developed markets, it’s closer to 2% to 3%. Removing government support in order to close that gap is a delicate process. Allow too many firms, or the wrong ones, to fail, and investors’ faith in the overall market will wobble, triggering precisely the crisis that Beijing wants to avoid.

Bloomberg’s China Credit Tracker is one metric by which to evaluate this high-wire act. By using public and proprietary data, it shines new light on stress in the riskiest corners of the country’s onshore and offshore credit markets.

It’s a barometer that shows whether one of the most ambitious plans to reshape capital markets is going as planned—or whether cracks are starting to show. Put simply: The higher the score, the more troubled the companies and skittish the investors, relative to historic averages.

So far, policymakers have avoided prompting panic. The stress in both the onshore and offshore markets is in the middle range, according to our overall gauges, a sign of market resilience despite fears of a looming debt restructuring at state-run bad-loan manager China Huarong Asset Management Co. and serious doubts over the long-term health of China Evergrande Group.

While the monthly gauge showed stress remained elevated in the domestic market in May, it eased last month. These scores draw from Bloomberg’s proprietary database of onshore defaults and from yield spreads that show it’s becoming cheaper for even risky borrowers to sell debt.

The data also suggest that spillover pressure from Huarong and Evergrande has remained relatively contained in the local market. The firms are the latest in a string of borrowers once considered impervious to default that are now seen as vulnerable.

In the $860 billion market for Chinese dollar bonds, where global investors are most exposed, stress is higher. Investors are turning sour on junk bonds, pushing yields to their highest in more than a year and pressuring monthly returns.

Defaults aren’t going away anytime soon. The pace of missed payments has reached a fresh high in 2021, crossing the 100 billion yuan ($15 billion) mark for a fourth year in a row several months earlier than last year. Notable pockets of risk include property developers and local state-owned firms.

A ramping up in credit stress can be seen since February, when monthly defaults reached their highest levels relative to historic data, though the pace has since cooled off a little.

A host of defaults related to failed conglomerate HNA Group Co., once the poster child for China’s debt-fueled overseas acquisition spree, has led to rising number of failures in the southern province of Hainan.

Provincial Breakdown

Hainan topped onshore corporate defaults in the first half of 2021

Note: Map shows Mainland China’s onshore bond market. Figures are in billion yuan.

Source: Bloomberg

While elevated defaults are likely to continue through this year, authorities were expected to ensure financial markets remained relatively stable as the nation approached the politically sensitive 100th anniversary of the ruling Communist Party on July 1.

Firms that could face pressure repaying their debts need to deal with some 121 billion yuan that comes due through 2022.

Tracking Trouble

Monthly maturities for Chinese firms that could struggle to repay their debt

Note: Figures are in billion yuan.

Source: Bloomberg

Even if stress does increase, that’s not necessarily negative.

In fact, for China, more deliquincies are a crucial part of developing a mature, efficient market. Ultimately this will help reduce the country’s longstanding moral hazard problem by forcing buyers to reprice risk, push authorities to improve transparency and help attract long-term investors like pension funds and insurers from overseas.

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