Once China began to mark an exceptionally difficult transition from a smokestack economy to a consumption and services-led model, those who were aware of how the country had gone about funding years of torrid growth knew what was likely coming next.
Years of borrowing to fund rapid growth had left the country with a sprawling shadow banking complex and a massive debt problem and once commodity prices collapsed – which, in a bit of cruel irony, was partially attributable to China’s slowdown – some began to suspect that regardless of how hard Beijing tried to keep up the charade, a raft of defaults was inevitable.
Sure enough, the cracks started to show earlier this year with Kaisa and Baoding Tianwei Group and as we documented last month, if you’re a commodities firm, there’s a 50-50 chance you’re not generating enough cash to service your debt:
There’s only so long this can go on without something “snapping” as it were because even if Beijing intends to perpetuate things by continuing to engineer bailouts (e.g. Sinosteel), that will only add to the deflationary supply glut that’s the root cause of the problem in the first place and ultimately, Xi’s plans to liberalize China’s capital markets aren’t compatible with ongoing bailouts so at some point, the Politburo is going to have to choose between managing its international image and allowing the market to purge insolvent companies.
On Wednesday we get the latest chapter in the Chinese defaults saga as cement maker China Shanshui Cement Group Ltd said it won’t be paying some CNY2 billion ($314 million) of bonds due tomorrow.
Oh, and it’s also going to default on its USD debt and file for liquidation.
Here’s Bloomberg with more:
On Wednesday, the creditors got their answer. Shanshui, reeling from China’s economic slowdown and a shareholder campaign to oust Zhang, said it will fail to pay 2 billion yuan ($314 million) of bonds due on Nov. 12, making it at least the sixth Chinese company to default in the local note market this year. Analysts predict it won’t be the last as President Xi Jinping’s government shows an increased willingness to allow corporate failures amid a drive to reduce overcapacity in industries including raw-materials and real estate.
Shanshui’s troubles — it will also default on dollar bonds and file for liquidation — reflect the fallout from years of debt-fueled investment in China that authorities are now trying to curtail as they shift the economy toward consumption and services. In the latest sign of that transition, data Wednesday showed the nation’s October industrial output matched the weakest gain since the global credit crisis, while retail sales accelerated.
“Debt wasn’t a problem during the boom years because profits kept growing,” Zhang said last month. “But it’s not sustainable when the economy slows.”
Shanshui’s total debt load as of June 30 was four times bigger than in 2008, according to data compiled by Bloomberg.
Defaults in China’s local corporate bond market have mounted this year as the economy weakened. Sinosteel Co. last month failed to pay interest on 2 billion yuan of notes maturing in 2017. Baoding Tianwei Yingli New Energy Resources Co., whose majority holder was until last year the world’s biggest solar panel company by shipments, failed to make a complete payment on a note due Oct. 13.
There’s also a shareholder spat with the chairman going on here, but in the end, this is story fits perfectly with the narrative as laid out above and as we’ve documented on too many occasions to count. This is a perfect storm involving heavily indebted producers whose businesses have become uneconomic in the face of a sharp downturn and efforts to keep them afloat have only served to exacerbate the same overcapacity problem that forced them into de facto insolvency in the first place.
So where do we go from here? Well, nowhere good and in a sign of things to come, Bloomberg also reports that Yunnan Coal Chemical has some CNY1.31 billion in overdue debt “due to continuous losses and rising financing.”
As we noted earlier this month, as of this moment China has between $25 and $30 trillion notional in financial and non-financial corporate credit (in China, where everything is government backstopper, there isn’t really much of a difference), about 5 times greater than the market cap of Chinese stocks (and orders of magnitude greater than their actual float), and 3 times greater than China’s official GDP, which also makes it the biggest bond bubble in the world, even bigger than the US Treasury market.
For their part, BofAML thinks this entire debacle could begin to unravel in earnest in about six months and on that note, we’ll once again close with the list of who’s most likely to be next: