Economic slowing adds to risk on Chinese financial markets

BOFIT Viikkokatsaus / BOFIT Weekly Review 2015/18

While corporate solvency struggles have been visible for years, the first default on a domestically listed corporate bond issue only occurred in March 2014. Last month saw the first state-owned enterprise default on interest payments. Last week, the first Chinese firm defaulted on foreign bonds payments, leading to open speculation of deeper problems brewing. The stock of non-performing loans held by banks has also soared, even if the share of nonperforming loans in overall credit stock is still relatively small.

Because the public sector typically intervened in payment issues earlier to prevent market disruptions, these defaults may be a positive signal of long-awaited market discipline. Despite their high visibility, the impacts of these defaults on markets have been limited.

The emergence of payment problems, however, also reflects risks of a slowing Chinese economy, declining corporate profits and soaring indebtedness. Local government debt struggles and the decoupling of stock markets from trends in the real economy further increase financial market tensions. The deregulation of interest-rate setting and capital movements, along with other reforms, add to tensions.

The current financial market developments have largely been anticipated and various degrees of disruption are expected ahead. An encouraging sign is that the government has stuck with reform policies. The experiences of other countries with debt problems and financial market deregulation, however, suggest possible unpleasant surprises ahead.

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