Photographer: Nelson Ching/Bloomberg

Schwarzman Deems China Defaults Good as Markets Embrace Failure

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You’d think two defaults in two days would be negative for markets in China.

Apparently, they’re not. Investors seem almost downright happy about missed interest payments by Kaisa Group Holdings Ltd. and Baoding Tianwei Group Co. this week, and are responding by piling more money into the Asian nation’s securities.

The thing is that the defaults broke new ground for the tightly-controlled economy. Rather than being supported by the government, these corporate failures are being viewed as a maturation for the world’s second-largest economy just as it shows real signs of slowing -- growth last year was the weakest since 1990.

“It’s a positive development,” Steve Schwarzman, Blackstone Group LP’s chief executive officer, said in an interview in New York. “The government communicated about two years ago that they would start allowing defaults, so the market was prepared.”

In other words, don’t worry too much about the losses inflicted on bondholders from corporate failures -- the fact that China is willing to let these companies go down shows how confident the nation’s leaders are that their economy won’t just collapse with a little added stress. Part of that comfort may stem from the stimulus being deployed by its central bank, which cut the reserve-requirement ratio for banks by 1 percentage point on Sunday.

Bond Reaction

So, defaults may just be the way that China establishes itself as a developed economy, instead of an emerging market. China wants the International Monetary Fund to add the yuan to the ranks of the world’s reserve currencies; it wants to challenge the U.S. dollar’s domination in global finance.

“It’s a positive development seeing these types of things occur,” said David Lebovitz, a global market strategist at J.P. Morgan Asset Management in New York. “For so long there’s been this impenetrable wall, which is the Chinese government standing behind these companies.”

Letting companies go bust may be one way to tell the world your markets are for real. That it’s not just a one-way trade in the China bond market. On Tuesday, Baoding became the country’s first state-owned company to default on an onshore bond. A day earlier, Kaisa became the nation’s first real estate company to miss payments on its dollar-denominated debt.

Default Outlook

While China’s junk-bond market fell 0.5 percent Monday, it’s still up 2.3 percent for the month, more than twice returns for U.S. speculative-grade securities, according to Bank of America Merrill Lynch index data. The Bank of America Merrill Lynch China Broad Market Index rose 0.2 percent that day.

And in the first trading day after Chinese developer Kaisa reneged on its dollar debt, the Shanghai Composite Index climbed 1.8 percent to a seven-year high and China’s interbank borrowing rates dropped to a four-month low.

The good news for traders who are finding comfort in the failures is that more may be in the offing. A report last week by Standard & Poor’s said that “more defaults cannot be ruled out” as earnings for Chinese property developers suffer.

Of course, there’s risk and potential pain associated with that outlook. China’s corporate debt is the highest in the world, former central bank adviser Yu Yongding wrote in the official China Daily last week. Companies had $14.2 trillion in debt at the end of 2013, exceeding every other country including the U.S., which had $13.1 trillion in company obligations, S&P said in a June report.

At the same time, these defaults and the losses associated with them may be what actually make China’s corporate-bond market legitimate.

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