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[Anjani Trivedi and Shuli Ren] China’s default wave spares the biggest fish

Brace yourself: A growing number of hard-up Chinese borrowers are not making good on their debts. The pattern is all too familiar.

After a record year of defaults in 2018, two big issuers failed to meet their obligations in recent weeks. Coal miner Wintime Energy Co., one of China’s biggest defaulters last year, missed interest payments again this month. Beijing Orient Landscape & Environment Co., which builds water-treatment plants, was late on a 500 million yuan ($73.8 million) bond due this month.

The most obvious revelation from the latest hubbub is that private companies continue to bear the brunt of tighter credit conditions. Despite the government’s recent pledges to help tide them over, small enterprises still lack refinancing options as the shadow-banking crackdown presses on. With around 3 trillion yuan of onshore corporate bonds set to come due this year, the odds are not looking good.

Funding costs remain relatively high for small and struggling private borrowers. Amid the central bank’s recent easing measures, the yield on debt of high-quality, state-backed issuers has dropped to 3.8 percent. Meanwhile, the yield investors demand to hold weaker, private names has barely budged, hovering around 7 percent for a five-year, AA-rated Chinese corporate issuer.

This widening spread does not so much reflect market fear (there is not much) as it demonstrates the divergent fortunes of Beijing’s favorites and the rest -- namely the manufacturing-heavy private industrial complex.

Even more distressing, however, is that state-owned borrowers are benefiting from Beijing’s bounty at the expense of their private peers. Just six of the 38 defaults in 2018 were central or regional state-owned enterprises, according to Goldman Sachs Group. And almost 5 percent of all private-sector debt outstanding was in default last year compared with barely 0.1 percent for SOEs. That is particularly striking given SOEs’ bond issuance far outweighs that of private-sector companies, which make up around a fifth of the market.

One problem is that when things get tight, government-backed companies end up squeezing cash from their private suppliers and customers. Listed SOEs owe the private sector 2.1 trillion yuan in the form of net account receivables, estimates Gavekal Dragonomics. This effectively amounts to an interest-free loan from the private sector.

Beijing Orient Landscape is a good example. An active player in Beijing’s public-private partnership drive, the firm received close to 70 projects from the government worth 120 billion yuan between 2015 and 2017.

But it has not been able to collect what it is owed. Account receivables ballooned to almost 10 billion yuan at the end of the third quarter, a 58 percent jump from a year earlier. While the company still boasted a 16 percent operating margin, operating cash flow fell into the red as early as June.

Beijing Orient’s filings show it is desperate for cash. On Feb. 1, the firm raised 780 million yuan from a two-year bond at a higher coupon than its issues last year. Days later, it looked to raise another 1 billion yuan from a 270-day note, promising a 6.5 percent coupon.

As a result, private businesses could easily run into cash crunches, especially as industrial profit growth turns lower. For the first three quarters of 2018, net profit of listed nonfinancial private firms rose 57 percent from a year earlier to 697 billion yuan. But the cash from operations that they brought in was only 333 billion yuan, less than half of their operating profit. SOEs, on the other hand, are doing far better: They earned 2.2 trillion yuan in operating cash flow, twice their operating profit.

The Chinese government’s measures to provide relief through tax cuts has also favored state-backed firms. Manufacturing businesses pay five times as much value-added tax as industrial SOEs, according to HSBC Holdings. These private businesses have accounted for around 59 percent of all VAT payments, further shrinking their pockets.

Credit defaults, in theory, have a silver lining. In a world without them, there’s little to differentiate sterling firms with sound finances from riskier companies barely squeaking by. Yet Beijing’s selective rescue tactics ensure that won’t really happen, leaving private companies to lick their wounds -- again and again.

Anjani Trivedi and Shuli Ren
Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. -- Ed.