The other big story in the Emerging Market (EM) world aside from the conflict in Ukraine/Russian conflict is the changing nature of the Chinese economy. The 2013 3rd Plenum, a meeting of Communist Party’s Central Committee, seemed to suggest a more market-driven philosophy to guiding China’s economy moving forward having massive consequences for China going forward.
This week, I’ll be focusing on China.
Why a default may be a good thing
On March 7th, something remarkable happened in the Chinese corporate bond market (I know, it sounds awesomely interesting, right?) – a Chinese corporate bond failed for the first time in history.
Just a quick rehash, a bond is basically an “I-O-U” from a company to an investor. Investopedia does a great job explaining it:
The indebted entity (issuer) issues a bond that states the interest rate(coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually).
The bolded words are my emphasis. Reason why I included that explanation is that when I say ” a corporate bond failed” I mean that a Chinese corporation, in this case a Shanghai based solar panel company named Shanghai Chaori Solar, did not pay back its interest payments, around $15 million USD, at a previously agreed upon date implying that the company does not have enough funds to do so. In other words, they defaulted.
Now, since China started its bond market in the 1990s, there have been some technical defaults among Chinese corporations, meaning that the interests payments have been made but some other clause of the bond contract was not upheld (to be fair, the United States has technically defaulted as well BUT NOT CANADA).
China’s somewhat default-free debt market is not due to all of the companies being financially responsible but rather a lot of them being bailed out by the Chinese Central Government before defaulting. Thus, March 7’s Chaori serves as a warning shot to Chinese corporations to get their fiscal house in order because they may not be bailed out anymore. In fact, China’s premier Li Keqiang warned that this may be the year corporate defaults as China ramps up its financial regulation. Indeed, this is a warning instead of a disaster since the Chinese government has noted defaults will be “controlled” in order to prevent systemic banking risk.
Going forward, this is just another part of China’s effort to “liberalize” its economy by letting the market, rather than government intervention, determine the credit-worthiness of Chinese corporations.
Forbes – Some of the implications of China restructuring its corporate bond market.