After years of supporting inefficient companies, China is now allowing them to go bankrupt.
China is turning the screws on the country’s businesses as authorities seek to take advantage of the global pandemic to bolster its industrial might.
After allowing inefficient companies to survive for years, Beijing is now allowing them to go bankrupt. Bond defaults hit a record $ 30 billion in 2020, including leading companies that previously relied on implied government guarantees. Supervision and sanctioning of credit rating agencies is on the rise, as national stock exchanges delisted at least 16 stocks from their top boards last year – the largest amount of data dating back to 1999.
The trend is expected to accelerate in 2021 as China’s central bank tightens financial conditions, making it more difficult for public or private companies with insufficient cash flow to survive. An economic recovery and a strong currency give policymakers more leeway to focus on reducing the amount of debt in the financial system, which accounts for a record 277% of domestic production.
“The good thing is that China will keep financial risks under control, but the bad thing is that it will not bail out companies unless they are in an extreme situation,” said Larry Hu, head of the Chinese economy at Macquarie Group Ltd. “The government wants to take advantage of a strong recovery in growth to tighten monetary policy. We may see more companies struggling to find liquidity.”
Beijing has implemented more measures in recent months to increase the efficiency of the country’s financial markets, as well as the quality of its businesses. In December alone, China tripled the maximum jail term for securities fraud to 15 years, proposed to shorten the delisting process for unprofitable stocks, and pledged to improve oversight of the industry. the country’s credit rating. China has also imposed a cap on bank loans to real estate developers, an industry laden with debt.
In November, the main securities regulator pledged to tighten control over China’s initial public offerings, while an October crackdown on the convertible bond market – a funding tool widely favored by risky issuers small cap – involved the publication of 37 guidelines in a single day.
As China hardens on the industry, its loosening of control over financial markets will allow investors – rather than the state – to punish poorly run companies and reward growth. Concern over China Inc.’s dependence on US markets for fundraising may have partly motivated this action, as well as the Communist Party’s economic strategy of “dual circulation” which prioritizes building demand. interior.
While the People’s Bank of China is unlikely to raise interest rates in the coming months, it has repeatedly indicated that it will moderate the supply of cheap credit. The timing makes sense – booming export growth has given the central bank the opportunity to scale back stimulus measures deployed during the coronavirus pandemic.
But the consequences for the most vulnerable companies can be brutal: Beijing’s commitment to normalize policy was a factor behind a sudden wave of corporate defaults late last year, which in turn froze loans in the interbank market. The World Bank has also warned that excessive policy tightening could hurt the global economic recovery.
Financing China’s future growth engines without destabilizing its heavily leveraged financial system requires a carefully calibrated rebalancing of the world’s second-largest economy. For China and its businesses, a change of this magnitude can only succeed if those with weak finances and poor returns are allowed to go bankrupt, according to Carlos Casanova, an economist at Union Bancaire Privee.
“The authorities will continue to walk a tightrope between stabilizing growth and reducing economic fragilities,” Casanova wrote in a December memo. “For China’s debt restructuring strategy to go as planned, the pace of financial reform must accelerate rapidly.”
–With help from Tian Chen, Ken Wang, Yue Pan and Molly Dai.