China’s first domestic corporate bond default, a historic event, is ringing alarm bells over the nation’s credit market. Yet one thing is certain: It is important that it was allowed to happen.
Shanghai Chaori Solar Energy Science & Technology had been in trouble for some time. Last year, the company logged a third straight annual net loss. It had faced the threat of bankruptcy on several occasions.
Overproduction is a notorious problem for China’s solar energy sector. A bitter trade dispute with the European Union, which ended with curbs on Chinese exports, dealt a further blow to an industry in crisis. Though Chaori’s default was the first of its kind, Suntech Power Holdings, once the world’s largest maker of solar panels, last year defaulted on $541 million in U.S. convertible notes.
The debt interest unpaid by Chaori as of the March 7 deadline is relatively small, at around 90 million yuan ($14.6 million). That is a mere fraction of the 8.5 trillion yuan overall market. What makes the Chaori case so significant is that, for the first time in mainland China, a company with domestic debtholders has failed to find a savior and must pay for its own errors.
It seems China is facing up to the realities of the market, where success and failure are both possibilities.
Success should be tied to ability — what you know ought to be more important than who you know. But the opposite has hitherto prevailed in China. Personal and political ties are more relevant than the market’s mandates. Companies in crisis are saved by government intervention, either because of hidden interests or in the name of stability.
The implicit assurance that companies would be rescued in emergencies encouraged investment in corporate bonds and kept coupon rates low. White knights have taken many forms: a friendly bank, direct intervention by Beijing or an obscure channeling away of bad debts. Now we have a sign this perverse mechanism may not continue.
For a deeper understanding of Chaori’s downfall, one has to look to China’s political arena.
The central government has warned against misguided investments in an already mature sector and the continued extension of credit to failing organizations. For years, it has attempted to guide the country toward a different development model, one that puts the stress on quality rather than quantity. In pursuit of its vision, the government has eagerly acquired foreign technology and regularly increased wages by law. The higher wages have pushed up the cost of labor-intensive manufacturing, a sector deemed less crucial for China’s new growth model. At the same time, pay hikes encourage internal consumption and reduce the nation’s dependence on exports.
These are grand ideas, but the central government is hindered by its own weakness. It may seem unlikely in a one-party country, but economic interests have created an array of lobby groups that cannot be controlled.
The results of China’s $586 billion stimulus program, designed to mitigate the global financial crisis that began in 2008, stand as the most glaring example of the central government’s limited power. A lot of the money went to places that were not the government’s intended recipients. The old habit of investing in mature, crowded sectors prevailed, contributing to real estate bubbles and serious pollution in many parts of the country.
The solar panel industry was a case in point. Due to what Beijing has described as “blind investments” encouraged by local governments, the country is now making half of the world’s solar panels. New plants continue to be built despite a glut in global supply. One of Suntech’s white knights before its collapse was the local government of Wuxi, a city in Jiangsu Province.
Put another way, old models have been blocking a historic shift in China’s development. In this context, the failure of one small company becomes an important signal.
Perhaps, protection from failure and secure credit lines will no longer be guaranteed. Perhaps, businesses will be forced to take calculated risks, respect rules and operate according to market forces. The real issue is whether the government can implement its ambitious directives. Only time will tell whether Chaori’s failure represents the beginning of a new phase, or whether China’s top rulers will remain prisoners to unsustainable practices the government promoted in the past.
Published on Nikkei Asian Review