Defaults in China

CHINA ADVISORY - Report 30 Nov 2020 by Andrew Collier

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The recent wave of defaults has raised questions about China’s support for the state sector. It is unusual for Beijing to allow state firms to default on their bond or debt obligations, which opens the possibility of a failure of the state sector, and thus a risk to the economy from a systemic collapse of bond obligations. This is an unlikely outcome. China is simultaneously increasing credit to the economy through the banks while squeezing those sectors it believes are inefficient consumers of capital as a signal to the market. Widespread defaults are unlikely to occur, but if a chain reaction begins, Beijing would step in quickly through the PBOC or state proxies and halt the increase in defaults.

The pressure for capital by local governments is high, however. Land sales are weakening and local debt is unsustainable.

We can view China’s approach to economic restructuring and the implicit government “put” as a three-part policy:
1) Strengthen the court system to handle corporate defaults.
2) Make known its declining support for inefficient – mainly local – state firms that are squandering credit and increasing implicit government debt, through “signalling.”
3) Flood the banks, particularly the larger ones, with adequate liquidity to handle loans to corporates, including targeting the cash-short SMEs.