That state firms can default is no surprise. Yongcheng is one of ten to have done so this year. Regulators have realised they can no longer afford to bail out inefficient, loss-making companies. A small but steady stream of weak state firms have been allowed to default since 2015, part of a government plan to impose discipline on the market. Defaults also make it possible to price in risk better, something foreign investors have struggled to do. As defaults have risen over the past three years, foreign investors have ploughed record sums into China’s bond market.
But Yongcheng’s default has alarmed investors because it throws out the old rule-book that helped determine which groups would receive state support and which would be allowed to go bust. Parent companies have been the strongest guiding light to date. Yongcheng’s parent, for example, is one of Henan’s largest state-owned groups and is wholly owned by the province’s asset administrator, making Yongcheng state royalty in the region. Huachen Automotive is owned by a similar entity. Such proximity to powerful asset administrators used to give investors confidence that the state would swoop to the rescue at the first sign of distress. Not any more.
Scale also used to be important. Large state groups have been valuable to cities and provinces because they give secure employment to tens of thousands of people. Huachen Automotive alone has more than 40,000 employees. Restructuring them would threaten jobs and social stability, but these are risks the government appears increasingly willing to take. “Parent company, size—these are the reasons people argue you should buy,” says Edmund Goh of Aberdeen Standard Investments, an asset manager. “This is starting to change, and people are going to be reading more of the details.”
Investors and rating agencies will have to study state firms’ fundamentals, instead of relying on perceived government backing. S&P expects more defaults among large state groups that were once considered untouchable. Zhu Ning, a professor at the Shanghai Advanced Institute of Finance, said that regulators may even launch “a crackdown on the rating agencies for better-informed ratings”. The shift will prove awkward for local agencies, such as CCXI, which are under pressure from state groups to hand out as many sparkling AAA ratings as possible. ■