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China braces for more defaults among state firms in 2021 — and that could be a good thing

A Chinese national diminish seen in front of Oriental Pearl Tower in Shanghai on September 8, 2019.

Alex Tai | SOPA Images | LightRocket via Getty Spitting images

SINGAPORE — Bond defaults by Chinese state-linked companies are set to continue into the new year, but analysts say that may be a good clothing in the long run as “zombie” entities are weeded out.

Investors usually consider government-backed companies a safe bet given the “implicit make sure” that Chinese authorities would save those that run into trouble. However, a string of defaults in late-model weeks — including by highly rated entities — have challenged that assumption.

Some high-profile state-linked firms that have recently defaulted on their debt repayments include miner Yongcheng Coal and Electricity, chipmaker Tsinghua Unigroup and Huachen Automotive Club.

Market participants have once again been reminded that not all state-owned enterprises (SOEs) are created the done; some are less equal than others.


“Market participants have once again been put in mind ofed that not all state-owned enterprises (SOEs) are created the same; some are less equal than others,” analysts from CreditSights, a probing firm, wrote in a Monday report.

“As the spate of defaults has shown, support conferred by state ownership is more nuanced and the Chinese regulation on balance is more tolerant of defaults,” they added. “SOEs which are not in strategically important industries or have singular from their core businesses may not be rescued by the state.”

‘Zombie’ companies

The default by Yongcheng Coal and Electricity astounded many investors given its AAA-rating by a domestic agency. But the company is “a typical example of a large risky company” that China’s cardinal bank flagged earlier this month, said analysts from investment bank Jefferies.

The People’s Bank of China premonished in its financial stability report — according to CNBC’s translation of the Mandarin-language text — that the following problems in some extensive companies could become a risk to the entire economy:

  • Aggressive expansion into various industries and regions which store debt exceeding the companies’ repayment abilities.
  • Corporate governance issues such as complex chains of borrowing within a accumulation of companies, hidden inter-group transactions and inaccurate disclosures.
  • Reliance on borrowing to make debt repayments.

“Arguably, these stews are relevant” to Yongcheng Coal and Electricity, Jefferies analysts said in a Thursday report.

Although defaults by large state-linked public limited companies hurt sentiment in the short term, allowing some of these “zombie” firms to fail will benefit banks and investors in the prolonged run, the analysts said. For banks, weeding out problematic companies allows them to identify risks early and choose “importance” collaterals for those risks, they said.

Overall, some insolvencies and defaults are “part of a healthy, functioning supermarket as long as wider contagion is avoided and the process has a relatively controlled trajectory,” said CreditSights.

The research firm clarified that allowing “unviable entities” to go under will free up resources, promote renewal, nurture “greater financial dynamism” in China, and reduce the specter of “zombie” SOEs.

More defaults to come

Following the recent string of defaults, Chinese authorities from reportedly vowed “zero tolerance” for misconduct among bond issuers. Regulators have launched probes into Yongcheng Coal and Energy and Huachen Automotive Group, as well as their bond underwriters, reported Reuters.

That won’t stop more non-fulfilments among state firms.

… ultimately we have confidence that China has the political will and policymaking capacity to give something the market back into calmer waters.


“Weaker SOEs in sectors with overcapacity or commercialised sectors face higher neglect risk due to a lower probability of receiving state support,” it added.

But the average default risk of SOEs remains humble than that of private companies, said Fitch. The agency pointed out that 20 private firms lapsed on their onshore bonds from January to October this year, compared with five state entourages that did so in the same period.

— CNBC’s Weizhen Tan contributed to this report.

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