China is putting some big numbers on the economic scoreboard. Though President Xi Jinping set a goal of 6% growth this year, many, including the International Monetary Fund, think 8% is more like it.
Yet even as China teases a “V-shaped” recovery, these aren’t the figures that matter most. Those are: 1.3 trillion and 18 trillion. The first is how much, in U.S. dollar terms, Chinese corporate debt is due over the next 12 months. The second is the size, also in dollar terms, of a mainland government bond market hanging in the balance.
All this might matter less if not for the ill-timed default drama over at state-owned China Huarong Asset Management Co., whose travails are stress testing the second-biggest economy. This Beijing-based institution seems as good a microcosm of China’s last 20 years as you’ll find.
It was one of four asset management giants established in 1999 as part of the government’s response to the Asian financial crisis two years earlier. Huarong’s focus was on distressed debt. It’s function, really, was as a stable repository for billions worth of dodgy loans made to state companies. A “bad bank,” if you will. It was supposed to act as a guardrail against a financial crisis, not cause 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 repay—or find ways to refinance—some $6.2 billion of debt. This tension is emblematic of the epic balancing act Xi faces in 2021: making good on deleveraging pledges—which means allowing more defaults—while also proving to global investors that China’s giant bond market is a safe place to invest.
On the one hand, leaving Huarong and its nearly $42 billion to the “market forces” Xi promised would guide his reform efforts. On the other, the chaos that would surely ensue could turn the biggest bond funds away from Chinese debt.
Fears of the latter happening explain why markets appear to be betting on a government solution to Huarong’s woes. Chairman Wang Zhanfeng can indeed argue that the buildup happened before his time—under Lai Xiaomin, who was executed in January as part of anti-corruption efforts.
Doing so, though, would fuel the very “moral hazard” the Xi era pledged since 2012 to eradicate. This makes Huarong the ultimate test case of Xiconomics. It’s also an ill-timed dilemma for Xi, as well as Finance Minister Liu Kin and People’s Bank of China Governor Yi Gang.
The amount of domestic corporate debt payments due this year is nearly a third more than in the U.S. and more than 60% above that in all of Europe. It’s enough to buy Alibaba Group twice over. And all these due dates come amid unprecedented wave of defaults by onshore debt issuers.
These underlying cracks in China’s financial system complicate is post-Covid-19 recovery.
China is still leading the globe out of the pandemic, and boosting exports for Japan, South Korea, Singapore elsewhere in Asia. It’s not all it seems, though, as analysts raise alarm bells about bubbles. Home prices, for example, are racing higher. Surging raw materials prices, meantime, are fueling fears of hoarding and runaway inflation.
Excessive debt, though, is the perennial concern. China tends to get away with moments of default chatter for a couple of reasons. One, investors who’ve bet on mainland debt reckonings don’t tend to do very well. Beijing has a knack for pulling off narrow escapes from crashes.
Two, China has the financial resources to save the day. The PBOC hasn’t gone the quantitative easing route, leaving considerable monetary latitude to pump into markets at times of turmoil. Here, think summer 2015, when Shanghai stocks plummeted 30% in the space of a few weeks. When markets are tanking, state-control has its benefits.
Yet the message of business as usual that bailing out Huarong would send might turn off foreign investors as much as it turns on risk-takers. If the lesson domestic borrowers learn from Huarong is that it’s safe to increase leverage anew, Chinese reform hopes are doomed.
Another problem: saving Huarong wouldn’t be easy. As Dinny McMahon at Enodo Economics points out, the scale is in some ways unprecedented. Huarong is about 70% bigger than Hengfeng Bank, the biggest financial institution authorities backstopped in recent years.
“Moreover,” he says, “of the $42 billion Huarong has raised in the bond markets, $23.2 billion is from overseas.”
Huarong, it’s worth noting, is 57% owned by China’s Ministry of Finance. With Xi’s reformers looking to change perceptions that state firms are free from the consequences of their overreach. This gets us back to Huarong’s role as a microcosm for market stumbles in 1997, 2008 and in 2020 amid Covid-19 chaos.
Thing is, Huarong’s problems aren’t new. “Rather,” McMahon says, “they’re born from reckless lending and overambitious expansion during the years following the  global financial crisis when China’s financial regulators were unable to keep risk-taking in check. That those problems are coming to a head now could presage a challenging year ahead for regulators.”
Investors, too, as they pile into China’s $18 trillion government debt market. Though concerns surrounding the Huarong mess are more of a corporate debt phenomenon, the poor transparency, weak credit rating system and under-developed market mechanisms contributing to the problem put China’s entire recovery narrative at risk.