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JPMorgan Says China SOE Defaults to Climb But No ‘Shock Therapy’

JPMorgan Says China SOE Defaults to Climb But No ‘Shock Therapy’

JPMorgan Chase & Co. predicted that defaults by China’s state-owned enterprises will climb, though officials will be careful to head off any sudden stop in credit that puts the financial system at risk.

“Credit risk is under-recognized” with regard to state enterprises, JPMorgan analysts including Katherine Lei wrote in a note to clients dated Tuesday. “We expect more defaults on SOE bonds or loans.”

The bank cited analysis of bond issuers’ financial data that shows there’s a greater share of debt at risk of non-payment than the current default ratio. The analysts also pointed to broader corporate-governance worries that surfaced with the recent case of an SOE removing assets from its balance sheet prior to defaulting.​

JPMorgan Says China SOE Defaults to Climb But No ‘Shock Therapy’

“This indicates a declining willingness to repay,” the JPMorgan analysts said of the incident reported about Yongcheng Coal & Electricity Holding Group Co., which defaulted on a 1 billion yuan ($152 million) note last week.

Also contributing to the expectation for more state-enterprise defaults are a winding back of fiscal stimulus and a less stimulative stance on credit creation on the part of policy makers. With China’s economic rebound strengthening, officials will be eager to move toward normalization, imposing a 2.2% fiscal “drag” on gross domestic product, according to JPMorgan.

Amid evidence of deepening stress among SOE bond issuers, officials from China’s State Council have asked government departments to conduct a risk assessment, according to people familiar with the matter. The aim is to prevent any spillover effects from the credit sphere that could cause financial systemic risks, Bloomberg reported Monday.

If there is a risk of contagion, the regulator will have a response plan, though the people said the initiative doesn’t mean there will be bailouts.

“We believe central government will adopt a gradual approach in resolving the SOE debt issue instead of ‘shock therapy,’” the JPMorgan analysts wrote, highlighting a separate study recently done by the bank’s economics team. The risk, however, is of lengthy, Japan-style stagnation, according to JPMorgan.

China’s rapid run-up in debt has been concentrated among SOEs and issuers tied to local governments, and structural reforms would be vital to “solve” the problem, JPMorgan economists led by Zhu Haibin wrote earlier this month. They pointed to the need for transparent bankruptcy processes and doing away with implicit government guarantees for debt.

Over time, China’s central government will probably take more debt onto its balance sheet -- lowering the cost of servicing the debt, by removing the premiums other borrowers must pay, Zhu and his colleagues wrote.

Policy makers will in time also pull down policy interest rates -- “eventually approaching the zero interest rate bound,” the team wrote. China for now remains one of the few major economies without near-zero, or even negative monetary policy settings.

“The debt resolution process (with either good or bad outcomes) could take a long time,” the economists wrote. “The risk is Japan-style distress and lost economic growth momentum.”

©2020 Bloomberg L.P.