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China set for red letter day over bond default


By Josh Noble in Hong Kong & Simon Rabinovitch in Shanghai

It is rare to see investors and economists come together to cheer a bond default, except it seems in China.

Shanghai Chaori Solar said on Tuesday that it would not be able to pay investors the Rmb89.8m ($14.7m) interest payment owed on money it borrowed two years ago, raising the prospect of China’s first true corporate bond default.

Analysts think a default in China is inevitable and most likely imminent. Many hope it will mark a change in the country’s financial markets, helping money flow to deserving companies at the right price.

The belief, repeatedly borne out, that the government always rides to the rescue of troubled borrowers, has encouraged investors to lend money at artificially low rates to weak companies. That has fuelled a pile-up of bad investments and a surge in China’s debt levels. Chaori has not yet missed its March payment, which is due tomorrow, meaning it could yet be bailed out as it has been in the past. The bonds themselves have not traded since July.

A high-profile default in the trust sector was narrowly avoided in January, when investors in a product backed by loans to a coal company were rescued days before maturity.

“A default would be a good thing for the development of the corporate bond market,” said Ivan Chung, a credit officer with Moody’s. “Investors have just been buying the bonds with the highest yields. Pricing does not reflect risk.”

Chinese companies have missed interest payments on bonds before – which would be classified as a default in developed markets – but bailouts have always ultimately been provided by third parties.

The Chinese bond market has boomed, partly on the back of the country’s 2009 stimulus package. The outstanding volume of corporate debt reached Rmb8.7tn at the end of January – up from Rmb800bn at the end of 2007, according to Bank of America Merrill Lynch.

Yet onshore investors know they need not worry about a wave of defaults. As much as 80 per cent of corporate debt issued in China comes directly from state-owned enterprises and local government investment companies, and these bonds are still seen as safe.

David Cui, China strategist at Bank of America Merrill Lynch, said the Chaori bond was backed by a local government and an underwriter with ample resources to bail out investors.

“If the bond is allowed to default, we believe it will most likely be because the government wants to teach the market a lesson,” he wrote in a report.

Yields on Chinese corporate bonds have been rising steadily over the past six months, a reflection of wariness among investors about the risks in the credit market and tightening liquidity in the economy.


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