China needs a clear mechanism to address bond defaults

As China’s economic slowdown squeezes corporate profits, the country is facing a new problem: bond defaults.

A record number of Chinese companies are finding themselves unable to make payment on their debts. And the lack of an effective mechanism to deal with defaults means investors used to risk-free bonds are suddenly facing huge difficulty getting even a proportion of their money back.

Their only option seems to be a long and frustrating wait, with no guarantee of a satisfactory result.

Analysts see this lack of a reliable system to deal with bond defaults hampering the government’s prospects of building a mature financial market and potentially dampening its efforts to attract more overseas investors.

Before 2014, bond defaults had never worried investors in China, thanks to the rising corporate profits that accompanied China’s meteoric economic growth and the government’s implicit guarantee for bond repayments.

But now the risks are becoming real. As the mainland economy loses steam, many Chinese companies are finding it harder and harder to turn a profit. Meanwhile, as the government moves toward a more market-oriented system, it is increasingly refraining from providing guarantees for bond repayment.