Are Chinese private entities gradually moving away from relying on state credit?

Thomson Reuters News reported on March 24, 2014 that several Chinese computer peripherals and semiconductor companies are flashing signs of defaulting on their bond payments. There are other Chinese companies in various industries that are facing similar issues, with some reporting tight credit conditions, and worrying signs of defaults as measured by their total debt ratios. The Chinese government has started their pro-market reform plans, but are also vigilant about potential risks of a credit contagion if reforms are being meted out at a pace where many Chinese firms might not be able to cope with the potential fallouts of such an event.

According to a quote made by one of the Hong-Kong based analysts working for credit ratings firm, Standard & Poor’s, he mentioned that risks are ‘incremental but controlled’ with sectors including shipbuilding, metals, and mining, and materials among those showing the highest risk as China’s economic growth slows and banks tighten credit. In addition, Thomson Reuters data showed that Chinese companies owed just over USD 1.0 trillion worth of domestic bonds, of which 15.8 percent is coming due this year.

With all the impending signs of a tightened credit environment in China, are Chinese companies fully embracing with the market realities that the Chinese government will not stand ready to support credit ailing firms provided that they are not in positions of posing any systemic risks to the entire financial system? It appears to be as most of the latest wave of defaults including the latest real estate firm, Zhejiang Xingrun Real Estate Company, and Shanghai Chaori Solar Company have so far led to minor short-term shocks to the Chinese stock markets, but have not sparked off any credit contagion-like events. Both companies are not financial firms, and did not appear to pose any systemic risks. However, there are questions of ‘what if’ scenarios if say many banks that have loans tied to many of these so-called ‘at risk’ or credit-laden firms turned sour, how will the Chinese government react? Will it step aside and allow large scale defaults to overwhelm the financial system? This is certainly a far-fetched scenario, and no government in any proper sense will allow such credit events of such magnitude to jeopardise both the domestic and global financial systems. However, the risks are real, and cannot be ruled out given the current economic slowdown, and a much tighter credit environment many Chinese companies are experiencing.

The Chinese companies are facing harsh realities of operating in a new regime in Beijing, and it is widely thought that not a lot of these companies, especially the small-and-medium sized firms will be able to withstand such credit shortfalls. It could also cause slowdowns in capacity expansion plans, halts in production, and potential hiring freezes of additional labour. The Chinese government is aware that if policy makers were to over tighten the ‘noose’ on credit flows, massive shortfalls in production, and unemployment will be the policy casualties, and it will also be part of an inevitable tradeoffs that they have to take into consideration. The Chinese government is treading carefully as it gradually rolls out its pro-market reform plans.

International aid agencies, including International Monetary Fund’s (IMF) Managing Director, Ms. Christine Largarde, who was on a recent visit to China to attend a forum, was quoted by Bloomberg News that during the forum as praising the Chinese government for embracing the necessary pro-market reforms, as the country is moving towards becoming being an integral part of the global economy. The short-term shocks are inevitable, but necessary in order to address the inefficiencies associated with state-controlled systems.

The Chinese companies that have been singled out for their relatively high financial leverages relative to the industry peers have so far replied to Reuters journalists with confidence with most of them telling the journalists that they are able to cope with the tightened credit environment, and are in no way showing any major signs of default in a scale matching to the two failed Chinese corporations that have been featured in several business and financial media recently. However, in terms of adapting relatively well to the new pro-market reform policies introduced in China, most of them have expressed their uncertainties, and this could dampen confidence, when the Chinese government is just getting started with their pro-market reform agendas. The risk of any extreme policy moves that could trigger any massive defaults, potential investor backlash, and loss in investor confidence will be the among the last items in mind if the government were to simply announce sweeping changes without any proper consultation or warning to industry leaders of such policy moves.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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