Analysts at Goldman Sachs Group say the best way to determine if China is serious about structural reform of its corporate sector and curbing its addiction to credit-fueled growth is to watch the mainland’s bond market.

A worker walks past oil pipes at a refinery in Wuhan, Hubei province March 23, 2012. REUTERS/Stringer/File Photo
A worker walks past oil pipes at a refinery in Wuhan, Hubei province. REUTERS/Stringer/File Photo

According to Goldman Sachs, in the 10 years of its existence, China’s domestic corporate bond market has experienced only 18 official defaults, split between private companies and state-owned enterprises (SOEs). And the first didn’t occur until 2014.

China’s young domestic corporate bond market is therefore “a microcosm of the country’s credit issues,” writes Goldman’s Kenneth Ho. “Many SOEs rely on implicit government support to raise debt financing, with lenders often preferring to extend credit to state-related entities on the assumption that there will be government backing — creating moral hazard risks. In our view, allowing SOEs to default is a strong reflection of policymakers’ willingness to tackle moral hazard issues. And, again, this reflects what has been occurring in the broader credit market.”

Yet even these  18 “defaults” are perfect examples of moral hazard, reports Bloomberg. The Chinese authorities proved willing to provide support after the fact on almost all of them. Of the 18 defaults, Goldman said lenders received a full recovery in seven cases while 11 continue to play out in bankruptcy courts and elsewhere.

That leaves the number of companies — state-owned or private — that have left lenders nursing losses at a big fat zero, said Bloomberg.
However, non-performing loans are on the rise in China’s banking system So, how willing the country will be to take the bitter pill of defaults and losses in the name of structural reform and a reduced reliance on credit expansion will show how serious the policymakers really are.

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