China is putting big numbers on the economic scoreboard. Although President Xi Jinping has set himself a growth target of 6% this year, many, including the International Monetary Fund, believe 8% is more like that.
Yet even as China teases a “V” recovery, it’s not the numbers that matter most. These are: 1.3 trillion and 18 trillion. The first is how much, in US dollars, the debt of Chinese companies is owed over the next 12 months. The second is the size, also in dollars, of a continent’s government bond market that is at stake.
All of this might be less important if not for the untimely default drama of state-owned China Huarong Asset Management Co., whose sentences are stress tests the second largest economy. This Beijing-based institution seems as much a microcosm of China’s past 20 years as you will find.
He was one of four asset management giants created in 1999 as part of the government’s response to the Asian financial crisis two years earlier. Huarong’s focus was on troubled debt. Its function, in fact, was to store billions of bad loans to state enterprises. A “bad bank, “if you will. It was meant to act as a safeguard against a financial crisis, not to provoke one.
And yet, Huarong is now at the center of concerns about whether China Inc. can meet its domestic debt obligations this year. This year alone, Huarong must pay off – or find ways to refinance – some $ 6.2 billion in debt. This tension is emblematic of the epic balance Xi faces in 2021: keeping his promises of deleveraging – which means allowing more defaults – while proving to global investors that the giant Chinese bond market is a safe place to invest. .
On the one hand, leaving Huarong and his nearly $ 42 billion to the “market forces” promised by Xi would guide his reform efforts. On the other hand, the chaos that would surely ensue could hijack the biggest bond funds. Chinese debt.
Fears of the latter happening explain why the markets appear to be betting on a government solution to Huarong’s woes. President Wang Zhanfeng can indeed claim that the accumulation occurred before his time – under Lai Xiaomin, which was executed in January as part of anti-corruption efforts.
However, this would fuel the “moral hazard” that the Xi era has been committed since 2012 to eradicate. This makes Huarong the ultimate test case for Xiconomics. It is also an unwelcome dilemma for Xi, as well as for Finance Minister Liu Kin and People’s Bank of China Governor Yi Gang.
The amount of domestic corporate debt repayments owed this year is almost a third more than in the United States and more than 60% above that of all of Europe. Just buy the Alibaba group twice. And all of these due dates come amid an unprecedented wave of defaults by onshore debt issuers.
These underlying cracks in the Chinese financial system complicate the post-Covid-19 recovery.
China is still pulling the world out of the pandemic and boosting exports from Japan, South Korea and Singapore elsewhere in Asia. That’s not all it seems, however, as analysts are sounding the alarm bells about bubbles. House prices, for example, are going up. Soaring commodity prices, meanwhile, are fueling fears of hoarding and runaway inflation.
Excessive debt, however, is the ongoing concern. China tends to get away with moments of chatter by default for several reasons. First, investors who have bet on calculating the continent’s debt tend not to do very well. Beijing has the gift of success narrow escapes crashes.
Second, China has the financial resources to save the day. The PCB did not follow the quantitative easing route, leaving considerable monetary leeway to pump markets in times of turbulence. Here, think of the summer of 2015, when Shanghai stocks fell 30% in the space of a few weeks. When markets are booming, state control has its advantages.
Still, the business-as-usual message that Huarong’s bailout would send could discourage foreign investors as well as risk-takers. If the lesson domestic borrowers are learning from Huarong is that it is prudent to increase financial leverage again, China’s reform hopes are doomed.
Another problem: saving Huarong would not be easy. As Dinny McMahon at Enodo Economics points out, the scale is in some ways unprecedented. Huarong is about 70% larger than Hengfeng Bank, the largest financial institution supported in recent years.
“In addition,” he said, “of the $ 42 billion that Huarong has raised in the bond markets, $ 23.2 billion comes from abroad.”
It should be noted that Huarong is 57% owned by the Chinese Ministry of Finance. With Xi reformers seeking to change perceptions that state-owned enterprises are exempt from the consequences of their overbreadth. This brings us back to Huarong’s role as a microcosm for market failures in 1997, 2008, and 2020 amid the Covid-19 chaos.
The thing is, Huarong’s problems are not new. “Rather,” says McMahon, “they were born out of reckless lending and over-ambitious expansion in the years following the  global financial crisis when Chinese financial regulators were unable to control risk taking. The fact that these problems come to a head could portend a difficult year for regulators. “
Investors too, as they enter China’s $ 18 trillion government debt market. Although the concerns surrounding the Huarong mess are more a phenomenon of corporate debt, the poor transparency, weak credit rating system, and underdeveloped market mechanisms that contribute to the problem endanger the whole talk of recovery of China.