Global Source Partners
China’s State Council Tuesday issued a decree ordering a “deepening” of reform of the budget management system. The key point is an order to reduce financial risk and increase transparency of local government finance. This order follows the recent cancellation of the Ant Group IPO and stricter regulations of Ant’s online financial lending platforms, along with rising bond defaults. These events suggest an increasing trend toward de-risking and credit restriction in the economy. However:
- Is the government serious this time about credit restriction or is this going to lead to new forms of “creative financing” for local governments?
- Will holders of offshore USD debt issued by local corporations face a growing wave of defaults, as we have seen onshore with companies such as Huarong Asset Management?
The Huarong case is a real outlier. As far as I know, it’s the first central SOE to get to near default status. Bloomberg is reporting that a 600M bond due in Singapore is being repaid. Clearly this whole thing is political. I would, however, look at it from two frameworks. The first is the global investor reaction and attitude by Beijing, and the second is the systemic risk issue internally.
Globally, I think Beijing is far less reluctant to allow USD credit to default now than they may have been two years ago. First, their success with Covid has given them a degree of confidence in their ability to weather crises. Second, there has been a rapid increase in foreign capital entering China, mainly into CGBs but also into other bonds and equities. The Russell Index inclusion was quite significant, for example. Their attitude internally seems to be, we are one of the most successful and largest economies in the world, why should we be concerned about international opinion? This is particularly true post-Trump, as he squandered what little leverage we had.
That doesn’t mean they are unconcerned about global opinion or defaults in general. There are issues of pride, access to capital (less important in my view), and the fact that Huarong is centrally state owned (an embarrassment for the MOF). (I think I read that the MOF is transferring its stake to CIC but I may have that wrong — if that is true, that is an interesting development, as the MOF would clearly be trying to distance itself from this disaster). But what they may do is repay many of the bonds, particularly this first one coming due, to quiet the global concern, but let one or two others default, as a warning bell to investors to examine these credits more closely. Bottom line, this international analysis of domestic Chinese finance is way more important (at least to the PBOC) toward improving the financial system than the money itself. Similar to the WTO entry in 94.