China’s premier warned that future defaults on bonds and other financial products were “unavoidable”

Last updated: March 13, 2014 2:04 pm

Fresh corporate default tests China’s resolve

By Lucy Hornby and Jamil Anderlini in Beijing

China’s premier warned on Thursday that future defaults on bonds and other financial products were “unavoidable” as the failure of a steel mill in the north of the country to pay off loans risks triggering a cascade of bad debt.

Li Keqiang told reporters that China was likely to see a series of defaults as the government accelerates financial deregulation but said his government would take steps to ensure they do not pose a threat to the wider financial system.

In the past, the government has always stepped in to bail out companies but as he steps up financial reforms, Mr Li has decided to allow several small, mostly privately owned, companies to default in order to address the problem of “moral hazard” in the economy, according to people familiar with the government’s thinking.

Some analysts have warned that by doing so, Beijing may trigger investor panic and prompt a “Lehman moment” in China’s increasingly debt-dependent economy.

Beijing’s challenge is laid bare by the failure of Haixin Steel, a privately owned medium-sized mill in the heart of China’s coal country, to repay loans that came due last week. The default, disclosed to the Financial Times by steel traders, could send shockwaves through the local banking and shadow banking sectors.

Partly in response to rumours surrounding Haixin’s default, Chinese onshore iron ore spot prices fell more than 10 per cent this week to levels last seen in 2009. That helped trigger steep drops in global markets for the metal, which rely heavily on cues from the gargantuan Chinese economy.

Haixin is the largest privately owned steel mill in Shanxi and accounts for 60 per cent of the tax revenues in Wenxi County, home to 400,000 people in China’s coal heartland.

Haixin was also the lead investor, together with other local private companies, in Jinshang Investment Guarantee, which backed other companies’ debts for a fee. On Thursday, a website describing the credit guarantee company’s operations appeared to have been shut down.

Steel traders fear Haixin is deeply entangled in triangular debts with coal suppliers and other local companies and that its inability to pay back loans to state banks could trigger a wave of defaults through the region.

On Thursday, employees and the local government said Haixin is still operating, albeit at very low production levels.

“We are operating as usual. We don’t have any problems,” said an executive at the mill’s head office. He referred questions on the loans to the mill’s owner, who could not be reached.

“It’s a very sensitive time and a sensitive matter. The municipal government has attached great importance to the matter, they are working as hard as they can to solve the problem,” said an official at the Wenxi County trade and economic bureau, who would not give his name.

Haixin is the second-largest steel mill in Shanxi Province but it does not rank among the top 30 mills in China by production volume.

Chinese steel mills are struggling with severe overcapacity, heavy debt loads and a softening market and over half of them are losing money by some estimates.

Mr Li’s administration has vowed shut down lossmaking, highly polluting producers in industries such as steel, cement and glass and also tackle the problem of moral hazard in an economy that saw its first bond default in recent history just last week.

Chaori Solar, a small privately owned solar panelmaker, last week failed to pay the interest on Rmb1bn ($163m) worth of bonds it sold two years ago.

It is still possible Beijing will decide that the systemic risks of allowing Haixin to go bust outweigh its usefulness as a warning to the wider market.

“We have been paying great attention to risks from financial sectors and debt,” Mr Li said on Thursday at his annual press conference in response to a question from the Financial Times. “We must enhance oversight and solve problems in a timely way to ensure no systemic and regional risks.”