China About to hit its Bear Stearns Moment?

HAS China arrived at its Bear Stearns moment? Analysts at Bank of America Merrill Lynch, an investment bank, worry it may have done so after the first default in China’s domestic bond market since the central bank started regulating the market in 1997. On March 4th Shanghai Chaori Solar Energy Science and Technology Co, a struggling solar-equipment supplier, declared that it lacked the cash to make the full interest payment on a corporate bond.

Fear of a chain reaction leading to a liquidity crunch seems excessive. After all, the troubles of the country’s solar industry (wracked by overcapacity and drowning in red ink) are well known. Suntech, once the world’s biggest solar firm, defaulted last year on debt owed to foreign investors.

Chaori itself has already escaped an earlier potential bond default, thanks to intervention by its local government. Although the amount due this week was trifling (less than $15m), no government bail-out was on offer. An insider adds that the firm may eventually default on the 1 billion yuan ($163m) principal that is owed as well as on the interest payments.

Most analysts are relaxed. Sun Jianbo of China Galaxy, a local stockbroker, argues that this default is unlikely to lead to a meltdown of China’s nascent but fast-growing market for corporate debt (see chart). He believes that there are two kinds of Chinese domestic bonds: those with strong government support and those with limited official backing. Because the market did not expect Chaori to be bailed out (unlike, say, important state-owned enterprises), panic will be limited, he says.

Fitch, a ratings agency, even declares that this default will be a “long-term positive for the market.” Voices in this camp believe that officials are allowing a default by a minor firm as a signal to investors to start pricing risks properly. Ivan Chung of Moody’s, another ratings agency, notes that the absence of defaults has left the immature market without the proper infrastructure for working out such things as creditors’ meetings, bankruptcy proceedings and the pecking order of various bondholders.

Moreover, there is little chance that a default this week will to lead to a broader bond-market seizure. Many corporate bonds are still held by banks and insurers to maturity, limiting the scope for panic.

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