Chinese government defers another default but only for the time being
Developer dodges failure to repay its debt this time, but Beijing cannot beat the odds forever
Odd as it may sound, the fact that Huatong Road & Bridge Group dodged a default on July 23 is bad news.
Until Wednesday, markets had been buzzing about the possibility the Shanxi-based builder might become the second mainland company in four months to renege on a bond payment. Then, Huatong beat the odds, repaying all principal and interest on a US$65 million bond. How? Some aggressive fundraising, along with a little help from local government bodies. According to press reports, municipal officials intervened to prevent the company's collapse.
Two immediate worries spring to mind. One, the mainland's moral-hazard bubble continues to swell as public officials insulate companies from the effects of bad business decisions. For all the talk of epochal reform on the mainland, there's still no price to pay for questionable borrowing and lending. Two, local government debt is growing even as Communist Party leaders pledge to reduce public liabilities.
A recent analysis shows that as of July 23, 20 of 25 provinces and provincial-level cities reported a pickup in growth in the first half. Some of the gain, of course, is the result of central-government stimulus: expedited railway spending and tax cuts. Most of it reflects local fiscal pump-priming, funded by untold billions of dollars of fresh debt.
The big worry is that we just don't know how bad the mainland's debt profile really is. As of June 2013, local government debt had swelled to about US$3 trillion. Given efforts since then to meet growth targets, it's a pretty safe assumption that the figure is now considerably higher - and poised to rise further.
Beijing's directives are working at cross purposes. On the one hand, Xi and Premier Li Keqiang say they want to end the GDP-leads-to-promotion mindset that has long motivated regional officials. Meanwhile, pressure to meet Beijing's growth target has reached obsessive proportions.
The harder the mainland works to avert a debt crash, the bigger it will ultimately be. "Repeated moves to shore up short-term growth may have averted fears of an economic downturn, but they haven't boosted confidence in the mainland's longer-term prospects," Andrew Batson, China research director at GaveKal Dragonomics, writes in a July 24 report.
"To do that requires sweeping regulatory changes that can fundamentally change businesses' calculation of future opportunities. Xi has in fact promised such changes, but has yet to deliver."
Letting Shanghai Chaori Solar Energy Science & Technology miss a US$15 million bond coupon was heralded as a welcome sign of discipline. Efforts to avoid a second, bigger default this week suggest officials really don't have the tolerance for the pain needed to put China on healthier footing.
For some China watchers, the real test of Xi's determination to end the mainland's moral-hazard culture will be letting a local government default, not some previously unknown road-builder. Unfortunately, if this pattern continues, there will soon be all too many potential candidates.