Today's PRC Pt II: Letting SOEs Fail

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No longer a novelty: a Chinese SOE that goes belly up.

Warren Buffett had a memorable turn of phrase when he said that we can identify who's naked when the tide rolls out. With the recent slowdown of China, we are seeing a similar phenomenon. Many--myself included--believed that the PRC would extend unconditional help to distressed state-owned enterprises (SOEs) when push came to shove. As any number of these SOEs are coming under distress, we are finding that there is no "blanket" coverage for these firms as quite a few have been left waiting for a state rescue that may never come:

China’s state-backed companies no longer have the ironclad support of the government -- and that’s bad news for the equity bull market in Hong Kong, says UBS Group AG.

Three of the seven Chinese companies that defaulted on debt repayments this year are partly owned by the state, including Baoding Tianwei Group Co. [also see here] The end of implicit government support will drive up funding costs and undermine foreign investor confidence in the 20 percent rebound by the Hang Seng China Enterprises Index, said Lu Wenjie, a Shanghai-based equity strategist at UBS.

"People are realizing national SOEs can default, local government-owned enterprises can default -- anything can default," Lu said. "H-share investors, especially foreign investors [Hong Kong-listed shares of stock of PRC-headquartered firms], haven’t paid much attention to this yet, so the risk isn’t priced in."

Is it the end of implicit guarantees? If so, the risk factor may not be adequately "priced in" as of yet:

Defaults are a relatively new phenomenon in China, which had its first such case only in 2014. The rising number of payment failures is reverberating across the nation’s $3 trillion credit market, with onshore junk debt heading for its biggest monthly selloff since 2014, issuers canceling bond sales and Standard & Poor’s cutting its assessment of Chinese firms at the fastest pace since 2003.

The widening of credit spreads from eight-year lows also threatens an incipient economic recovery, which has been mainly supported by a surge in cheap lending.

It's the [Western] notion of "moral hazard" being realized: Instead of the PRC bailing out nationally-owned firms in the event of trouble, it appear as though it's becoming more selective. What remains to be seen, though, is what happens if and when the really large Chinese firms run into trouble which have systemic importance like, say, its four big banks. I believe the "too big to fail" phenomenon will be observed since the recent bankruptcies were all of (relatively) smaller firms.

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