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China is hurtling toward another record year of onshore bond defaults, testing the government’s ability to keep financial markets stable as the economy slows and companies struggle to cope with unprecedented levels of debt.
At least 15 defaults since the start of November have pushed this year’s total to 120.4 billion yuan ($17.1 billion), within a hair’s breadth of the 121.9 billion yuan annual record in 2018, according to data compiled by Bloomberg.
While the defaulted notes amount to a small sliver of China’s $4.4 trillion onshore corporate bond market, they’ve fueled concerns of potential contagion as investors struggle to gauge which companies have Beijing’s support. Policy makers have been walking a tightrope as they try to roll back the implicit guarantees that have long distorted Chinese debt markets, without dragging down an economy already weakened by the trade war and tepid global growth.
“The authorities have found it hard to rescue all the companies,” said Wang Ying, a Shanghai-based analyst at Fitch Ratings.
This year’s China debt woes have spread to a broad array of industries, from property developers and steelmakers to new-energy firms and software makers. The types of borrowers facing repayment difficulties has also expanded from private companies and local state-run firms to business arms of universities, an obscure and loosely regulated corner of China’s corporate world.
One of those business arms, Peking University Founder Group, rattled investors on Monday after failing to repay a 2 billion yuan bond. The same day, Tunghsu Optoelectronic Technology Co., a maker of photoelectric display components, failed to deliver early repayment on both interest and principal for a 1.7 billion yuan note.
Recent signs of stress have also popped up in China’s offshore market, which has so far been more insulated from defaults.
Tewoo Group Co., a major commodities trader from the northern city of Tianjin, is poised to become the most high profile state-owned enterprise to default in the dollar bond market in more than two decades. The company has recently offered a debt restructuring plan that entails deep losses for investors or a swap for new bonds with significantly lower returns, the first of its kind for an offshore SOE issuer.
Tewoo Group is likely to default on its $300 million dollar bond due Dec. 16, one of the notes included in the plan, according to investors who cited the company’s offshore debt manager.
Despite the drumbeat of bad news, analysts say the threat of a systemic debt crisis in China remains distant.
“I don’t think it is a tipping point,” said Todd Schubert, a managing director for fixed income at Bank of Singapore. “China is a big market with a lot of issuers. In a functioning capital market, one would naturally expect some defaults.”
The onshore default rate in China this year is expected to remain the same as last year’s 0.5%, S&P Global Ratings said in November.
In a report on Tuesday, Fitch said the default rate for bonds issued by non-state Chinese companies increased to a record 4.5% in the first 10 months of 2019, adding that the figure might understate the true level of defaults given that some borrowers settle with bondholders privately rather than through clearing houses. The default rate for state-owned companies was just 0.2% thanks to financial support from the government and better access to funding from banks, Fitch said.
Read more: Secret Bond Deals Making China’s Debt Market More Confusing
Faced with a corporate debt pile that swelled to a record 165% of gross domestic product last year, Chinese policy makers are allowing more bond failures in part to impose increased discipline on borrowers and investors.
“Rising defaults should be a natural part of credit-market cycle,” said Anne Zhang, head of Asia fixed income for JPMorgan Private Bank. “It is long-term positive for any market to develop a good pricing mechanism for risks.”
Still, the process will be less rocky for investors if policy makers work to improve the transparency around defaults, according to Cindy Huang, an analyst at S&P Global Ratings.
“So far, defaults and recovery can be unpredictable,” Huang said. “This will hinder market confidence and weaken the healthy development of China’s credit market.”
(Adds details from Fitch report on default rates in 13th paragraph)
--With assistance from Rebecca Choong Wilkins, Tongjian Dong and Kari Lindberg.
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