The Week In Hindsight, 07 March 2014

Chinese policy makers reaffirmed the nation’s GDP growth target this week, at 7.5%,  just as concerns over the financial system ratcheted up a gear once again.  This was as Chaori Solar Energy Science and Technology became the first domestic corporate bond default on record for China, effectively ending a period of state backed, or assurance guaranteed capital markets.

Despite that Chaori is just a small company with an overall market capitalisation of CNY2.2 billion (£220 Million), Chinese debt and equity markets shuddered with trepidation at the time of the announcement. This is understandable given the number of corporate bonds now in issue, a number which has multiplied ten times over the six years since 2008.

The total amount of wealth now tied up in them is estimated at 8.7 trillion yuan (£800 billion). With the Chinese economy slowing and funding conditions tightening, companies of all sizes are now finding it more and more difficult to finance deficits in times of difficulty.

Given that Chinese authorities have this time allowed a capital markets issuer to default on its debts to investors, the perception that Chinese corporate bonds come with an implicit form of state guarantee has now been shattered.

With this, funding conditions are now likely to become much tighter for companies who are considered to be on the rocks. This could potentially have a compounding effect on rate of defaults that now occur and at the very least underlines the reasons for why we have been so keen to observe price action in China from a distance as opposed to becoming overly tempted by the low valuations.

On this subject, our outlook here remains unchanged although we will continue to monitor the situation on the ground in China while providing updates as and where warranted.

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