Moody’s report raises spectre of China defaults

The risk of default for some entities owned by China’s regional and local governments (RLGs) is rising and recent defaults involving state-owned enterprises (SOEs) indicate material limitations to the amount of actual support that the RLGs can provide to these entities, warns Moody’s.

“Against the backdrop of sector overcapacity and central government-sanctioned sector restructuring, we think the central government is increasingly unlikely to facilitate support for RLG-owned issuers unless they are engaged in activities closely aligned to an important national policy or it is concerned a default could have wider systemic implications,” said Ivan Chung, a Moody’s associate managing director.

“The recent defaults involve those of the bonds of two provincial government-owned SOEs – Dongbei Special Steel and Guangxi Non-ferrous Metals Group – in the onshore market, and illustrate our conclusion about the limitations on RLG support for their SOEs. We further believe that onshore bond defaults will continue to rise despite credit aggregates continuing to outpace nominal gross domestic product (GDP).”

The forecasts are part of the credit ratings agency’s just-released report, entitled ‘Chinese Overcapacity Sectors: Financial Stress Tests Implicit Local Government Support’.

The report notes that the current down-cycle in sectors showing overcapacity – such as steel and mining, and rising defaults in the onshore bond market – has increased banks’ and bond investors’ risk aversion towards weak issuers.

“Although there is pressure on lenders from the RLGs to maintain credit lines, the two cases cited suggest that such moral suasion may have become less effective, at least in the case of SOEs in overcapacity industries,” said Chung.

“Moreover, while we expect RLGs to continue to enjoy support from the central government, this may not necessarily translate into their ability to downstream support to SOEs in a timely manner.”

For example, while RLG-owned steel companies employ huge number of people and contribute significantly to the local economy, the central government is keen to curb their overcapacity to resolve structural imbalances that hinder economic rebalancing.

Moody’s notes that as the central government has already set aside a 100bn renminbi (RMB) compensation fund to support laid-off workers, debt restructuring is a more likely option than direct bailouts for financially distressed issuers in sectors with overcapacity . Debt restructuring typically involves credit losses to various kinds of creditors.


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