China’s debt milestone as the first company defaults

Corporate failure is a hallmark of capitalism, so the news that a struggling Chinese company had defaulted is a real milestone.

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.

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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.

Andrew Van Sickle

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.