After the 19th National People’s Congress (NPC) of the Communist Party of China last month, investors should expect more defaults from Chinese bond issuers as the government sends a signal that it intends to reduce leverage in the financial system.
Sean Taylor, chief investment officer for Asia-Pacific and head of emerging markets at Deutsche Asset Management, in an interview with The Asset, says: ‘If you read all the comments behind the [NPC], President Xi is obviously much more in control of the economy than a year or so ago.
‘The debt-to-GDP ratio has not really changed but that requires a long-term solution. It’s the short-term leverage that is being taken out. It’s the leverage within the financial system that is really unnecessary.’
Taylor notes that, since the NPC, the authorities appear determined to reduce the short-term leverage in the financial system, even if this means allowing defaults among poorly performing companies.
‘I think we will see more defaults, and we as a team would welcome that because of all the differentiation that would result. The economy is in much better shape now than it was three to four years ago,’ he says. ‘Three to four years ago defaults were not being allowed to happen. The fact that they’re allowing [them] to happen now I think is positive, because they’re allowing the normal market system to work.’
To demonstrate his point, Taylor cites the case of Dandong Port, a privately held company, which on November 1 was reported to have defaulted on payments to its five-year bond issue amounting to RMB 1 bn ($151 mn) with an initial coupon rate of 5.86 percent.
This was the first default reported since the NPC, though there had already been reports of defaults by Chinese bond issuers indicating general weakness in the market. In September, Wuyang Construction Group, a builder in the eastern province of Zhejiang, reportedly defaulted on two notes totaling RMB 1.36 bn the previous month.
Ratings agency Fitch Ratings also issued a report on September 24 saying it expects the first local government bond defaults in China.
