WHILE the attention of the Philippines recently has been understandably focused on the apparent explosion of construction activity being carried out by China on disputed shoals in the West Philippine Sea, a “told you so” moment in the Chinese economy has captured the attention of the global business media in the past few days.
Earlier this week, property developer Kaisa Group Holdings Ltd. became the first Chinese company of any consequence to default on its dollar-denominated debt, after a 30-day grace period on $52 million in missed interest payments expired. Altogether, Shenzhen-based Kaisa is saddled with a 65 billion yuan (about $10.5 billion) debt that it may not be able to repay, according to a Bloomberg report.
On Tuesday, Baoding Tianwei Group Co., a unit of the state-owned China South Industries Group Corp., missed a payment of 85.5 million yuan ($13.8 million) of interest on outstanding bonds, becoming the first government-controlled enterprise to slip into default.
Neither of these two defaults comes as a surprise to economic analysts. China has been judged to have an unsustainable amount of corporate debt for the past couple of years, and with a real estate “bubble” – albeit not an obviously dangerous one – having been created by speculative development and the most recent economic indicators showing a cooling of the overall Chinese economy, a default by one or more of China’s highly-leveraged companies was considered a matter of “not if, but when” by most pundits. China, however, has a knack for making analysts look foolish.
Many have been predicting the collapse or at least a major downturn of the Chinese economy for years, but it was really only in the first quarter of this year that the first visible cracks in the armor appeared with the cooling of a number of economic indicators such as exports, factory output, and GDP growth. A debt default of one or more large companies under those circumstances was considered inevitable.
What should happen in the wake of one or more large corporate defaults is an increase in corporate bond yields, and specific sharp increases in the yield of credit default swaps and bonds rated as “junk bonds.” But nothing in China works as one might expect. After the Baoding Tianwei default, yields on CDS actually dropped one percent, after a half-percent decline on the day the default was disclosed.
Chinese financial markets have not reacted in the usual way, either; in two days after the default, the Shanghai stock exchange gained nearly 153 points, or about 3.6 percent. Authorities at the People’s Bank of China have expressed confidence that the economy will not suffer severely under the circumstances, particularly since the PBOC also lowered the reserve requirement ratio (RRR) for banks for the second time in as many months, shaving one percent from the RRR to lower it to 18.5 percent. The move, which followed a 0.5 percent decrease in the RRR last month, is expected to pump an estimated one trillion yuan into the Chinese economy.
A large-scale default on a corporate debt issue can have a far-reaching impact on the economy; how China manages this unwelcome development will provide some lessons for the Philippines. These are lessons the country’s economic managers should take to heart, because the Philippines, despite constant reassurances from the government and those with an uncritical outlook, is flirting with some of the same problems – heavy speculative investment in real estate, inflated company and share valuations, and a currency whose value is carefully stage-managed by the central bank, sometimes with apparently little regard for real-world conditions. These characteristics led to trouble for China, not as quickly as many believed (or hoped) it would; if the Philippines follows the same model, it risks the eventual manifestation of core issues that need to be solved.
As always, facilitating an open, productive economy as opposed to one designed to gather only low-hanging fruit is the best solution of all. We hope that President B.S. Aquino 3rd, or probably more appropriately, those who make decisions for him grasp this concept without needing a big corporate debt default to remind them.