Sinosteel's Not-Default and More Moral Hazard: Katrina Nicholas

Sinosteel Co. looks set to avoid recording the first default by a Chinese steel company and a central state-owned enterprise. Good news for bondholders; not so good for the development of the nation’s debt market.

The company provided additional collateral for its 2017 yuan notes and extended their redemption by one month until mid-November. Sinosteel is said to be in discussions with the National Development and Reform Commission, which also is planning to meet with investors in the company’s securities.

The likely rescue of another company opens a familiar can of worms for China’s markets. Figuring out credit risk will remain an opaque process of assessing a firm’s political connections and social importance. Without defaults, the true risk of corporate failure remains obscured, and that can only encourage moral hazard. Capitalism without bankruptcy is like Christianity without hell, as the saying goes: Why bother watching debt levels when the government stands ready to pick up the pieces?

Sinosteel Co. is owned by Sinosteel Corp., one of 112 central state-owned enterprises. That gives it more heft than, say, Baoding Tianwei Group, a smaller and much less indebted state company that was allowed to default in April.

Sinosteel has also been on authorities’ radar since last year, when a company official acknowledged financial difficulties amid local news reports that the parent enterprise had more than 10 billion yuan ($1.6 billion) in overdue loans. That increased the likelihood of a response.

While Sinosteel technically missed Tuesday’s interest-payment deadline, the government’s involvement and the fact that the company added collateral mean there’s a decent chance investors will get their money back, eventually.

Sinosteel is unlikely to be the last company to need help. Corporate leverage is escalating, and Chinese borrowers had $14.2 trillion in debt at the end of 2013, exceeding every other country including the U.S. With the economy growing at its slowest pace in a quarter-century, the ability of some companies to service those obligations looks precarious.

A look at companies that have a) recorded a loss in the past 12 months; b) reported quarterly revenue growth that was zero or negative from a year earlier; and c) whose outstanding bonds and/or loans exceed their cash and equivalents, throws up 35 names. Most are in the energy, materials and industrial sectors:

Moreover, more companies in China are selling bonds than ever. Issuance this year is at a record, with about 13.2 trillion yuan of securities sold since Dec. 31, according to data compiled by Bloomberg.

That will surely mean more defaults. In the end, authorities can’t bail everybody out. If China is serious about giving markets a decisive role in the economy, it should bite the bullet now and allow more companies to fail. The cost would be some short-term pain. The reward would be a genuine market that prices capital according to risk.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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