Chinese Debt Defaults

How many Chinese debt defaults will it take to alert the international business community to the risks of an economic slowdown in the land of Communist managed capitalism? Reuters reports that Chinese bottle maker Zhuhai Zhongfu is likely to miss a bond repayment.

Chinese bottle maker Zhuhai Zhongfu Enterprise Co Ltd said it was likely to miss bond repayments due next week, as regulators show increased tolerance for bond defaults even as economic growth slows.

If the company misses the payment, it will mark the fourth public bond default in China’s onshore bond market, and comes shortly on the heels of another onshore default in April and an increased tempo of Chinese corporate bond defaults offshore.

The company, which says it works with clients such as The Coca-Cola Co and PepsiCo Inc, said in a filing late on Thursday that it was still short of 447 million yuan ($72.16 million) to pay interest and principal on bonds due on May 28.

As the article notes this will be the fourth recent default in China’s internal bond market. And corporate bond defaults offshore by Chinese companies are happening more frequently. We have worried on these pages for some time about mounting Chinese debt and a not very transparent economic system. Our concern is that these Chinese debt defaults are the tip of the proverbial iceberg and that the Chinese economy and the Chinese yuan are set for a fall.

Chinese Bond Yields Rise

Chinese provinces are carrying a lot of debt and are having to pay higher interest rates in order to borrow. The Economic Times reports on China sovereign yields.

[T]he murky nature of the new provincial debt – nominally issued by the provinces but with strong backing from Beijing – could also be pressuring medium term sovereign yields, according to analysts. Money market investors may be stepping cautiously ahead of an expected bond default by Zhuhai Zhongfu Enterprise Co. , a bottle making firm. The company informed investors last week that it might be unable to fully repay 621.15 million yuan ($100.14 million) of principal and interest due May 28.

This is reminiscent of the Greek debt crisis in which bond investors demand a higher interest rate in return for taking on more risk. The situation is not as acute as with Greek debt but if the Chinese financial house of cards collapses the effects will be damaging and more widely felt than a Greek debt default. Chinese debt defaults could be felt across the wide range of developing economies that supply raw materials to China and Western investors with investments in China. The Chinese yuan would likely fall sharply if the economy in China tanks.

When Does Debt = Equity?

Bloomberg reports that China has passed France is the largest seller of “perpetual bonds.” New regulations allow Chinese companies to hold more than $50 billion in debt as equity!

China has surpassed France as the biggest perpetual bond seller this year, creating $15.7 billion of new debt that never has to be repaid and is classed as equity. Rating companies don’t see that as a cause for celebration.

Chinese companies now have at least $53.2 billion of the notes on the equity part of their balance sheets, reducing leverage on paper. In reality, debt burdens can be just as onerous because perpetuals typically have coupon increases after a few years that act as an incentive to repay the bonds, the three biggest rating companies said.

“Accounting standards treat these perpetuals as equity, but we treat them most of the time as debt,” said Kalai Pillay, a senior director at Fitch Ratings Ltd. in Singapore.

How far will this go until there are more and more Chinese debt defaults, a true recession and long term damage to the Chinese currency?