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April 11, 2016 4:40 a.m. ET
A rising tide of defaults is typically the start of a deep cleanse and a purge of weak companies. In China, a recent flurry of defaults may just be a list of companies Beijing decided aren’t all that important.
Already this year in China, an equal number of companies have defaulted on publicly traded bonds as in all of last year. Letting companies default—and presumably restructure—could be a positive sign that China will follow through on promises to use corporate restructuring to cut excess capacity, especially in industrial parts of the economy.
Yet China hasn’t appeared to take significant steps that would clean up the bad debt, rather than shunt it into another pocket of the financial system. In previous years either bond guarantors, local governments or parent companies have come to the rescue. Bohai Steel, whose provincial government owner set up a creditor committee, could conceivably be a step toward restructuring the debt, but no deal has been struck.
Despite the government’s pledge to let zombie companies go, not everyone appears to be treated equally. Smaller companies such as Dongbei Special Steel Group and iron-ore miner Zibo Hongda missed payments without a rescue-plan in sight. Meanwhile, state-owned Sinosteel has been able to extend the redemption deadline on its bonds at least five times. The risk is that China’s restructuring process fails to distinguish whether a company should be shuttered or just needs a balance sheet fix up to continue operations.
Add to this inconsistency a plan to salvage large, crumbling companies in overcapacity sectors by letting bank lenders convert debt to equity. The board of shipbuilder-turned-oil explorer China Huarong Energy in late March approved a plan to convert $2.7 billion of debt for an almost 90% stake in the company, which could just push the company’s day of reckoning to the future.
Not allowing zombie firms to fail on equal terms means there is no bottom line for investors to distinguish the real risk from the illusion of risk, or even where to start. Despite these emerging cracks, China’s almost $8 trillion bond market has been on a tear. Yields have dropped dramatically over the last year, and the domestic investor base seems uninterested in differentiating among good and bad companies. Spreads have only widened slightly in the past months, despite the wave of defaults.
Chinese corporate balance sheets will continue to be tested, and the defaults should continue. But as long as the debt cleanup is halfhearted, so will be the results.
Write to Anjani Trivedi at [email protected]