China’s debt milestone as the first company defaults

In most countries a corporate debt default would barely register: after all, companies often go bust. But in China they have so far not been allowed to collapse. So last week's news that struggling solar-equipment maker Shanghai Chaori had been unable to make a full interest payment, and was therefore in default, is a real milestone.

China's corporate debt has grown to around $12 trillion. Its government cannot feasibly stand behind every loan. Apart from anything else, a belief the state will step in if things go wrong encourages companies to take unnecessary risks. Since taking charge of China a year ago, the new government, led by President Xi Jinping, has pledged to give market forces a greater role in the economy. Corporate failure is a hallmark of capitalism. It encourages the efficient allocation of resources by ensuring money is invested where it will deliver the best returns. So this default by a minor firm is seen as "a signal to investors to price risks properly", says The Economist.

But while "such adjustments are necessary for China in the long run, [they are] risky in the short term", reckons Wei Yao of Socit Gnrale. There has been talk of a Bear Stearns' moment for China, with this bankruptcy foreshadowing a collapse of China's credit bubble. China's overall debt load has soared to around 200% of GDP in recent years.

Try 6 free issues of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up for MoneyWeek’s free twice-daily newsletter.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Sign up

It hardly helps that markets are so opaque, says John Foley on Breakingviews. It's hard to trace "chains" of debt in a crisis, "investors can find they have claims on borrowers they never imagined". That makes them more likely to panic, as in the US in 2007. Yet a subprime-style contagion seems unlikely. As The Economist points out, the corporate-bond market looks well insulated. Banks and insurers hold many bonds to maturity, limiting the scope for a selling panic. China is also well placed to prevent a meltdown. It has little public debt and huge foreign-exchange reserves, notes Bank of America Merrill Lynch. The state's grip on the banks remains tight too, making it easier to stop the system freezing. Tackling China's credit bubble shouldn't be a case of 2008 all over again.