Kaisa Group Holdings became the first Chinese developer to default on U.S.-dollar-denominated bonds this morning after missing $52 million of coupon payments on 2017 and 2018 obligations due in March. Kaisa is, and isn’t a special case. Kaisa’s business imploded in February after the company’s management quit over ties to China’s disgraced internal security chief Zhou Yongkang. Overall, Chinese speculative-grade bonds rallied this year, with yields down 75 basis points since Dec. 31, according to Bloomberg.
But Kaisa is not a one-off event, occasioned by collateral damage to a bond issuer in the context of a corruption probe. China’s authorities are determined to transform the Wild West stock and property markets into an efficient capital-raising machine, capable of financing small and medium enterprises, and able to reduce the overall cost of capital for Chinese companies. This policy motivates China’s authorities to ease monetary conditions, as in last weekend’s reserve-ratio reduction, which potentially makes another 1.4 trillion yuan available for loans. But it also motivates a crackdown on misbehavior, for example, the use of so-called umbrella trusts to circumvent margin financing regulations–not to mention ordinary corruption.
After the 2008 financial crisis, China’s authorities threw a vast amount of official financing and public spending at the Chinese economy to buffer the impact of the world crash. That worked, but it also created long-term distortions, including higher gearing of company balance sheets. The present reform regime presumes that there is no success without failure. The occasional bankruptcy will help instill market discipline. And unlike the Obama administration’s handling of the financial crisis after 2008 – where companies were fined and stockholders were prosecuted rather than individual malefactors – China’s authorities will send some people to jail.
These are growing pains. Expect it to hurt from time to time.
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