For decades, regardless of weaknesses or inefficiencies, an overriding certainty of state-backed capitalism in China has been that the government looks after its own.
That may be changing.
On Tuesday, a little-known power equipment manufacturer became the first state-owned company to default in China’s huge domestic bond market, throwing doubt on the long-held notion that such businesses have implicit government backing.
The company, the Baoding Tianwei Group, controlled by one of China’s biggest military contractors, said that it had missed a Tuesday deadline to pay about $14 million in interest due on bonds worth 1.5 billion renminbi, or $242 million.
The development could signal a watershed moment for China’s state-owned businesses, which tend to enjoy easy access to cheap sources of debt funding — often with little apparent regard for the health of their finances. It is also likely to give new weight to repeated pledges by the Communist Party leadership in Beijing to push through a number of financial reforms to give market forces a greater role.
“I think it’s probably just the beginning,” said Ying Wang, a senior director of corporate ratings at Fitch Ratings in Shanghai.
“It makes sense for more commercially unviable, inefficiently run state-owned enterprises to default, because otherwise capital can never be allocated efficiently among state and private enterprises,” Ms. Wang said. “And that runs against the government’s reform agenda.”
The bond market is a critical component of that reform effort.
China’s onshore bond market has doubled in size to more than $4 trillion over the last five years, and it is now the world’s third largest after those of the United States and Japan. It remains largely closed to foreign investors, but it is a primary source of local fund-raising, especially for state companies. Last month, Beijing unveiled plans for the bond market to provide more than $160 billion in refinancing to China’s heavily indebted local governments.
State-owned companies, most notably the Guangdong International Trust and Investment Corporation, have previously defaulted in overseas bond markets, leaving foreign investors nursing losses. That default, in 1998, was the first by a Chinese state-run firm since the Communist Party rose to power in 1949.
A number of private sector Chinese companies have defaulted in overseas bond markets, including, on Monday, the troubled property developer Kaisa Group. In March of last year, China’s onshore bond market experienced its first private sector default, by the Shanghai Chaori Solar Energy Science and Technology Company.
It is hard to know how the latest default will play out. China recently revamped its bankruptcy laws, but companies, their investors and the court system have little practical experience in this area.
“The government’s invisible hand has always been in play,” Ms. Wang of Fitch said of China’s short history of dealing with bond defaults. “We need to see a more consistent and orderly restructuring process from the legal perspective, so that when people invest in domestic bonds, they know how they can get their money back.”
How the situation at Tianwei is resolved will be an important indicator of China’s commitment to market discipline.
In the case of the Chaori default, outside guarantee companies were brought in, and bondholders were ultimately repaid all the principal and interest owed. Banks that made loans to Chaori without collateral, as well as the company’s large trade creditors, were hit with losses. But the Communist Party-controlled court ensured that ordinary investors and smaller creditors were not affected. Mass layoffs were avoided after a new owner was found for the company’s main businesses.
“Ultimately the question is one of market discipline,” said Charles Chang, the head of Asian credit strategy at Credit Suisse in Hong Kong. “In a free capitalist market, this is gained by default experience, but in China, this has yet to come in a meaningful way to the bond market.”
Tianwei, a maker of transformers and other equipment for China’s nuclear, solar and wind power industries, is based in the city of Baoding in Hebei Province. It is controlled by the China South Industries Group, which is one of the biggest defence contractors owned by the central government and one of more than 100 companies under the direct control of the State Council, China’s cabinet.
Tianwei had losses of about $1.6 billion last year, which it blamed on the poor performance of the renewable energy sector. In its statement on Tuesday, the company said it would continue to try to find ways to make the missed payments, including through the possible sale of assets.
“With the company’s huge losses in 2014 and a sharp rise in the ratio of our debts to assets, we lost financing capacity, and new funding has dried up,” the company said in a statement. “Despite great efforts on many fronts, we still haven’t been able to raise funds to meet our interest payments.”
A woman who answered the phone at Tianwei’s offices in Baoding on Tuesday said the company’s board secretary and its investor relations representative were travelling and could not be reached. No other executives were available for comment.
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