Moral hazard has arrived in China.
According to Chinese business publication Caixin, the first of China’s massive state-owned organisations has collapsed under the weight of $2.2 billion worth of bad debt in China’s interbank bond market.
The company, Guangxi Nonferrous Metals Group, filed for bankruptcy nine months ago but only got approval from the Chinese government to go bankrupt a few days ago.
This is different from other Chinese bankruptcies. It’s the first company in China’s super-liquid, over the counter interbank market to go bust. Past bankruptcies only involved bank or corporate debt, this one involves 108 creditors.
Of course, Guangxi Nonferrous Metals Group, a regional company that used a local government financing vehicle to grow before it was delisted in 2011, had been suffering losses for years before it defaulted on bonds and notes.
The harder they come, the harder they fall
This is an all-too familiar story for China’s massive state-owned (and quasi-state owned) industrial, manufacturing, and property companies. The building boom that expanded the Chinese economy over the last decade or so must, according to the government, slow down, and the economy must transition to one based less on that than on individual consumption and services like banking and retail.
But for that to happen, companies that are limping along must be put down in order to free up capital for healthier new enterprises. And the goods they make — their overcapacity — have to find somewhere to go despite a lack of demand not just from China, but from the entire world.
That is why Nomura wrote in a recent note that Guangxi is just the beginning:
This case will not be unique, in our view. We highlighted the risk of rising defaults earlier this year, especially in industries burdened with overcapacity. We continue to expect more defaults to come. We believe that we may see divergence in the credit bond market.
On the one hand, we expect the government to take over some corporate debt, most likely in the form of debt swaps or bail-outs, which will lower the risk and extend the maturity of some LGFV bonds… On the other hand, however, more defaults and bankruptcies are likely to be permitted, leading to a rise in risk premia.
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