China's Bond Defaults - An Analysis

In the recent past, value of China’s bond defaults has increased ten times, from USD 2.5 billion in 2017 to around USD 30 billion in 2020 (Graph A.1 in Appendix). Of China’s USD 13 trillion bond market, around 39 companies (both domestic & offshore) have defaulted on USD 30 billion worth of bonds in 2020, up by 14% (y-o-y) over 2019. Of these defaults, local defaults were CNY 137 billion (USD 20.5 billion) in 2020 over CNY 142 billion (USD 21.3 billion) in 2019, while offshore defaults were worth USD 9 billion last year as compared to USD 4 billion in 2019 (Graph A.2 in Appendix).

According to Fitch Ratings, China's SoEs have defaulted on a record USD 6.3 billion worth of bonds between Jan’20 and Dec’20. China’s Local Government Financing Vehicles (LGFVs, separate entities from the local government) as key entities for raising finances for undertaking infrastructure projects in China have abandoned bond sales or loan applications after SoE defaults such as that of Yongcheng Coal & Electricity. There has been a wide spread belief with domestic investors that SoE- backed entities carry no default risk because the central government will bail out investors to avoid economic and social unrest. This trend is changing now, leading to rising uncertainties with investors about the perceived safe havens in China. Further, China’s domestic credit ratings are misleading indicators for both domestic & foreign investors to buy its onshore bonds. A gap between the ratings issued by Chinese credit agencies and western ones is evident.

There have been misleading media writings of reduced bond defaults in Q1-Q3 2020. To be precise, estimated drop of 20% from Q1-Q3’20 in Chinese bond defaults has mainly been because of short term measures (delaying repayments, swapping bonds or cancelling early payment) to buy time with the credit risks remaining in the system. China’s gradual economic recovery from COVID19 is now letting the government to focus on its efforts towards containing financial risks in the economy – monthly onshore defaults in H2 2020 grew 47% over H1 2020.

There seems to be a provincial variation dimension to Chinese SoE corporate bond defaults. Concerns have been rising over the repayment risks for LGFVs from some provinces.  For example, the provincial governments of Liaoning and Henan did not support the local SoEs. Provinces such as Shanxi, Guizhou and Beijing have acted to maintain their support. Bonds issued by coal mining companies from Shanxi province suffered a sell-off recently as investor worries mounted, but the provincial government quickly announced that it would offer full support for all local SoEs to prevent them from failing.

Earlier, China’s defaults, which were confined to industries with excess capacity such as coal & steel, have spread to automakers & chip makers as well. The technology sector accounted for 28% of 2020’s total onshore defaults, led by state-linked Peking University Founder Group Corp. The consumer industry was next, due to Brilliance Auto Group Holdings Co.’s default, followed by the financial sector.

Bond defaults have also had their impact on stock markets. With Unigroup’s bond prices coming down, Shanghai Stock Exchange paused trading in the company’s debt. To ease market sentiments, China injected liquidity in the system through open market operations.

Chinese Vice Premier Liu He said that China will show “zero tolerance” for misconduct. Bond defaults by SoEs without any rescue from the government seem to play into China’s three year reform plan (2020-2022) for SoEs as approved by the Central Committee for Deepening Overall Reform on 30 June’20 & announced on 17 Sep’20. However, it is important to note that most defaults are in provincial SoEs and not Central SoEs where the government’s stance would have been different. Further, control of companies – SoE / private – remains with the state. SoEs are ordered to adopt commercial objectives but Party control has been tightened. Policy shift of no bail outs for SoEs is also an indicator / brand building to the international audience of China’s change in its protectionist policies and market inefficiencies for its support for SoEs.

Although bond defaults have been rising in China, it is unlikely that these will lead to systemic crisis in China. This holds true in case of onshore bond defaults as authorities have levers to support the companies of their choice. However, the same may not be true in case of offshore bond defaults, especially during 2021. In the offshore market, where Chinese companies borrow in foreign currencies, about USD104 billion worth of bonds will mature in 2021, 40% more than this 2020. While Chinese offshore default numbers compare with bond defaults of US & Europe, rising trend in offshore cross defaults is visible.

On the whole, shift in China’s policy towards allowing bond defaults indicate that China wants to end the traditional notion of rescuing the investors. This may adversely impact China’s economic recovery path for the Chinese companies which have depended on debt fueled expansion since 2008. The policy shift of allowing SoEs to default on bonds in China may be bad news for the weakest SoEs at present, it is expected to be an improvement for investors and the credit market in the near future.

APPENDIX

Graph A.1: Chinese Bond Defaults on the Rise

Graph A.2: Offshore Corporate Bond Defaults in China

REFERENCES

• Aljazeera News, Nov’20, “China corporate debt defaults trigger concerns of broader crisis”, https://www.aljazeera.com/economy/2020/11/13/china-corporate-debt-defaults-trigger-concerns-of-broader-crisis
• Asia Society Policy Institute, Dec’20, “State-Owned Enterprise - State-Owned Enterprise Policy Reform”, https://chinadashboard.gist.asiasociety.org/winter-2020/page/state-owned-enterprise 
• Bloomberg News, Nov’20, “investors-are-learning-to-live-with-china-s-corporate-defaults”, https://www.bloomberg.com/news/articles/2020-12-11/investors-are-learning-to-live-with-china-s-corporate-defaults
• Bloomberg News, Dec’20, “Why China’s Debt Defaults Are More Alarming This Time”, https://www.bloombergquint.com/quicktakes/why-china-s-debt-defaults-are-more-alarming-this-time-quicktake
• Bloomberg News, Jan’21, “China Record $30B Bond Defaults Seen Rising This Year”, https://www.bloomberg.com/news/articles/2021-01-11/china-s-record-30-billion-bond-defaults-seen-rising-this-year#:~:text=Defaults%20by%20Chinese%20companies%20are,total%20value%2014%25%20above%202019's
• Cambridge Associates, Nov’20, “China’s Onshore Bond Market: An Update”, https://www.cambridgeassociates.com/insight/chinas-onshore-bond-market-an-update/
• Chi Lo, Dec’20, “China’s SOE debt defaults: Don’t panic”, https://investors-corner.bnpparibas-am.com/markets/chinas-soe-debt-defaults-dont-panic/#:~:text=A%20number%20of%20local%20state,upward%20pressure%20on%20bond%20yields
• Gravitas, “Chinese State-owned enterprises default on $6.1 billion worth of bonds”, https://www.youtube.com/watch?v=6xHJmPyeJ9M
• International Monetary Fund Asia and Pacific Dept, Jan’21, “People’s Republic of China : 2020 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the People's Republic of China, https://www.imf.org/en/Publications/CR/Issues/2021/01/06/Peoples-Republic-of-China-2020-Article-IV-Consultation-Press-Release-Staff-Report-and-49992#:~:text=Summary%3A,and%20helped%20the%20economy%20rebound
• JP Morgan Market Bulletin, https://am.jpmorgan.com/au/en/asset-management/adv/insights/market-insights/market-bulletins/what-is-in-the-chinese-fixed-income-universehttps://am.jpmorgan.com/au/en/asset-management/adv/insights/market-insights/market-bulletins/what-is-in-the-chinese-fixed-income-universe
• Narayanan S, Dec’20, “China debt fears grow amid wave of corporate defaults”, https://asia.nikkei.com/Business/Markets/China-debt-crunch/China-debt-fears-grow-amid-wave-of-corporate-defaults
• Reuters Staff, Nov’20, “China Vice Premier Liu He vows zero tolerance for misconduct after recent bond defaults”, https://www.reuters.com/article/china-bond-default/china-vice-premier-liu-he-vows-zero-tolerance-for-misconduct-after-recent-bond-defaults-idINKBN28204K
• Reuters Staff, Dec’20, “China's Unigroup bond default triggers cross-defaults worth $2 bln”, https://www.reuters.com/article/china-unigroup-bonds-cross-defaults/chinas-unigroup-bond-default-triggers-cross-defaults-worth-2-bln-idUSL1N2IQ07T?edition-redirect=in
• S&P market Intelligence Report, https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/china-s-recent-state-%20linked-bond-defaults-pose-limited-systemic-risk-8211-analysts-617208%2025
• Wang Jun, July’20, “New three-year action plan to speed up SOE reform”, http://www.bjreview.com/Business/202007/t20200714_800214044.html
• Xie Yu,  Dec’20, “Chinese Chip Maker in Default on $2.5 Billion of Dollar Bonds”,https://www.wsj.com/articles/chinese-chip-maker-in-default-on-2-5-billion-of-dollar-bonds-11607593266
• Zhang Yue, Sep’20, “China rolls out new measures to boost reform and development of SOEs, private businesses”,  http://english.www.gov.cn/premier/news/202009/17/content_WS5f637c55c6d0f7257693c258.html