China allows Chaori Solar bond default

Chinese investors were given a wake-up call today as the country witnessed its first onshore corporate bond default in recent history.

Solar panels manufacturer Shanghai Chaori Solar failed to meet an Rmb89.8 million (£8.8 million) interest payment due today.

The default is being viewed as a landmark event because in the past struggling mainland companies have always been effectively bailed out by fresh soft loans from state-owned banks and politically connected third parties.

Analysts said the Chinese authorities allowed the default to take place this time because Beijing wants to make it clear to domestic investors that Chinese corporate debt is not a one-way bet, as part of efforts to normalise the country’s dysfunctional financial system.

“China needs real credit defaults to reduce the problem of moral hazard created by ‘implicit guarantees’ and to develop a healthy credit market,” said Barclays in a note to clients.

But others warned that the government’s new strategy might backfire and create a financial panic in the world’s second-largest economy. “We may see other bonds default this year,” said Li Ning of Haitong Securities. “If it’s a default by a financial institution, it may turn into an extreme situation somewhat like the collapse of Lehman Brothers.”

The Chinese bond market is small compared with the other stocks of credit in the country’s financial system, but it has been growing fast in recent years. More than $1.5 trillion (£897 billion) of bonds were outstanding at the end of January, up from less than $600bn at the end of 2007. China turned the loan taps on in the wake of the 2008 global financial crisis, allowing total credit in the economy to balloon from 140 per cent of GDP to more than 200 per cent this year.

Shanghai Chaori Solar’s troubles stem from excess capacity in the sector. It is said to have expanded recklessly from the lower-cost manufacturing of panels into constructing solar farms. Chinese steel production and shipbuilding firms are expected to come under greater scrutiny from investors.

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