Why China’s Debt Defaults Are More Alarming This Time

Chinese companies are facing a reality check after years of ramping up debt. A crackdown on unregulated lending -- so-called shadow banking -- and tighter rules on asset management made it harder for some to borrow fresh funds to repay existing debt, leading to a record number of bond defaults in 2018 and 2019. When the pandemic put business activity on hold in early 2020, policy makers initially rushed to prevent another wave of missed payments. As the year wound down, private-sector defaults seemed to be coming down but the list of state-tied firms in distress had grown, despite signs of an economic recovery. That new source of risk has roiled China’s credit markets, prompting a renewed emphasis on financial discipline and a “zero tolerance” approach to misbehavior.

Chinese defaults actually dropped by 20% in the first three quarters of 2020 to 85.1 billion yuan ($13 billion), according to Bloomberg-compiled data. That was largely due to pandemic-related measures in the first half: At least a dozen companies managed to relieve pressure by delaying repayments, swapping bonds or canceling early repayment. However, short-term measures often end up just buying time, while the credit risk remains. Defaults picked up again in the second half, and investors were predicting another record year. In 2019, onshore defaults totaled more than 141.9 billion yuan, dominated by private enterprises. (The 2018 total of 122 billion yuan was itself more than quadruple the level in 2017.) By late 2020, there were signs that the stress in the private sector was bottoming out. But a string of defaults among state-linked firms, long considered to be immune from such troubles because of their implicit government backing, has shaken investors’ confidence.