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String of defaults tests safety net for Chinese bonds

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When a state-owned coal company in central China defaulted on a bond worth $152m this month, the slip-up seemed unlikely to send tremors through the world’s second-largest economy.

Prior to the default by Yongcheng Coal and Electricity Holding Group on November 10, only five Chinese state-owned enterprises (SOEs) had failed to pay back bondholders in the first 10 months of 2020, according to Fitch Ratings — consistent with levels in recent years.

But within a fortnight, Tsinghua Unigroup, a high-profile state technology group, would also default. That prompted China’s top financial official, vice-premier Liu He, to warn borrowers that Beijing would take a “zero tolerance” approach to misconduct in financing deals, such as misleading disclosures, or attempts by companies to evade their debts.

The developments have rattled China’s nearly $4tn corporate debt market, of which state-owned enterprises are estimated to account for more than half. In the week after Yongcheng Coal’s default, at least 20 Chinese companies suspended plans for new debt issues totalling Rmb15.5bn ($2.4bn), all citing “recent market turmoil”.

Mr Liu’s warning challenges many investors’ long-held assumption that local governments will always bail out state-owned borrowers. Analysts now fear investors will take a dimmer view of the debt, piling further pressure on borrowers.

“People don’t de-risk because they think they can wait for governments to step in before they have to sell assets,” said Logan Wright, an analyst at research firm Rhodium Group. “But now there’s going to be greater government tolerance for pain.”

The recent defaults are different from those in previous years “because local governments are now being considered a source of risk themselves, rather than a source of stability”, he added.

“The risk is that these events have permanently broken investors’ trust in the blanket support of local SOEs by local governments,” Xiaoxi Zhang and Wei He, analysts at Gavekal, wrote in a research note. “It can be difficult to rebuild such trust once it has been lost.”

Foreign investors have been increasing their exposure to Chinese bonds, but remain cautious on SOE debt. According to Goldman Sachs, such investors own about 9 per cent of total onshore Chinese central government debt. But they hold less than 1 per cent of the country’s outstanding corporate debt — a market estimated at $3.7tn for non-financial companies, according to the Bank for International Settlements.

If domestic investors were to become similarly wary of local SOEs — which Gavekal estimates account for 60 per cent of all company debt — it could put even more pressure on such firms and their often cash-strapped government owners.

Some workers at Yongcheng Coal say they have not been paid for months, but many investors have been content to ignore warning signs because the parent company is one of Henan province’s largest energy groups and seemed to have plenty of cash on hand.

Huachen Automotive Group, another SOE that defaulted in late October, was also thought to have the backing of its government owner in north-eastern Liaoning province. One of Huachen’s units is BMW’s partner in its successful China manufacturing joint venture.

Yongcheng and Huachen had another thing in common: both companies’ debt was also deemed triple A by big rating agencies.

According to information provider Wind, 70 per cent of all outstanding Chinese corporate and government debt is rated triple A, despite economic stresses caused by Covid-19. While China has weathered the pandemic far better than any other big economy, full-year growth is projected to come in at just under 2 per cent — posing a severe test for companies used to 6 per cent or higher.

Overall credit growth in China has been stable this year, but many regions — Henan and Liaoning included — have been struggling. “When the economy is under pressure, government financial support is limited,” said Shen Meng at Chanson & Co, a Beijing-based investment bank.

Bar chart of  showing China’s domestic debt market by issuer

“There’s not enough credit flowing through the system as a whole . . . [local governments] are reacting to the fact they have constrained resources as well,” added Rhodium’s Mr Wright.

The defaults have underlined concerns around investor disclosure. In the immediate aftermath, a Yongcheng Coal executive told creditors that most of its cash was tied up in “restricted” deposits. Huachen in September transferred its shares in BMW’s JV partner to a separate subsidiary, which later pledged them to a creditor.

In its statement on Sunday, Mr Liu’s committee warned issuers that authorities would “severely punish” any instances of “false information disclosure [and] malicious asset transfers”.

Yongcheng Coal did not respond to a request for comment. On Monday, a Huachen subsidiary said in a statement that its parent was being investigated by China’s securities regulator for “alleged violations of information disclosure laws”.

Investors are waiting to see how far regulators are prepared to bear down on the market, given the risk of repercussions for the wider financial system.

Chinese officials “recognise there’s no lending discipline in the market”, said Michael Pettis, a finance professor at Peking University. “Right now is probably not the time to test what would happen if there were real, serious defaults and losses taken. But eventually they have to do it.”

Additional reporting by Sherry Fei Ju in Beijing



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Emerging Markets

Toyota faces Thai bribery probe over tax dispute

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Toyota is under investigation in Thailand over allegations that consultants hired by the world’s largest carmaker tried to bribe local officials in a tax dispute, according to Thai authorities, court documents and a person with knowledge of the matter.

The probe followed a filing last month in which Toyota revealed that it had reported “possible anti-bribery violations” related to its Thai subsidiary to the US Department of Justice and Securities Exchange Commission.

Toyota is one of the biggest foreign investors in Thailand, where it makes a large range of cars, vans and pick-up trucks for the local market and for export. The country is Toyota’s biggest manufacturing hub in south-east Asia. Prior to the Covid-19 pandemic, car sales had been strong in a market, where it has a 31 per cent share.

This month, Thailand’s Court of Justice said in a statement that it would take action against any of its judges found to have taken bribes. The statement, which the court described as a move to “clarify facts” in a news report on a foreign website, directly referenced a tax dispute involving Toyota.

“If the Court of Justice has received information or explicitly found that any judge committed an act of corruption to their duty, whether it is about bribery or not, the Court of Justice will resolutely investigate and punish any action which dishonours judges, undermines the neutrality of the court, or causes society [to] lose faith in the Thai justice system,” it said.

According to the court, the case involved a tax dispute worth Bt10bn ($320m) between Toyota Motor Thailand and tax authorities over imports of parts for its Prius hybrid model. 

The affair dates back to 2015, when Toyota’s Thai subsidiary was accused by local customs authorities of understating taxes by claiming that the imported Prius vehicles were assembled from completely knocked down kits, or imported parts that were later assembled in Thailand.

CKDs would have been subject to a discounted tax rate under a Japanese-Thai free trade agreement, but if the cars were fully assembled before being imported they would have attracted a much higher rate. 

Toyota appealed against a decision by customs authorities to impose a higher duty in 2015, but lost. 

Thailand’s Court of Justice has said that it had accepted a petition to review the case, but had not yet begun hearing it.

In its regulatory filing last month, Toyota warned that the US investigations regarding its Thai subsidiary could result in civil or criminal penalties, but the company has not disclosed any detail on the allegations.

In a statement, Toyota said it was co-operating with the investigations and declined to comment on the tax dispute in Thailand. “We take any allegations of wrongdoing seriously and are committed to ensuring that our business practices comply with all applicable government regulations,” it said.

The SEC and the DOJ declined to comment.



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Boris Johnson cancels India trip after Covid cases surge in country

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UK prime minister Boris Johnson’s trip to India this month has been cancelled as the country battles a new variant and a surge in coronavirus cases that is overwhelming hospitals.

A joint statement by the British and Indian governments said the decision to scrap the visit scheduled for next week was prompted by the “current coronavirus situation”.

The trip, during which Johnson had hoped to discuss the prospects of a closer trading partnership with India, was initially planned to run for four days but had been scaled back. The two leaders will speak remotely instead, with plans to meet in person later this year.

The cancellation came as India’s capital city region has been put under lockdown and authorities have prohibited the use of oxygen except for essential services, as the country battles a surge in coronavirus cases that is overwhelming hospitals.

India continues to set single-day records of coronavirus cases, reporting more than 273,000 new infections and 1,619 deaths on Monday, with the number of new cases growing by an average of 7 per cent a day, one of the fastest rates in any big country.

The surge is believed to be linked to a new B.1.617 variant that was first discovered in the country.

British health officials are investigating whether the variant should be reclassified from a “variant under investigation” to a “variant of concern” following the discovery of 77 cases in the UK.

“To escalate it up the ranking we need to know that it’s increased transmissibility, increased severity, or vaccine-evading, and we just don’t have that yet, but we’re looking at the data on a daily basis”, Dr Susan Hopkins, a senior medical adviser at Public Health England, said on Sunday.

Officials in Delhi announced it would impose a strict lockdown for a week, following Mumbai and other cities that have already placed curbs on movement.

States are running short of beds, drugs and oxygen, leading the central government to restrict use of the gas. “The supply of oxygen for industrial purposes by manufacturers and suppliers is prohibited forthwith from 22/04/2021 till further orders,” the central government said.

Arvind Kejriwal, chief minister of Delhi, said “oxygen has become an emergency” in the region because its quota had been diverted to other states. He warned there were “less than 100 ICU beds” available.

The new restrictions have been imposed even as Prime Minister Narendra Modi and his ruling Bharatiya Janata party have hosted huge political rallies and allowed religious festivals attended by tens of thousands of maskless people in recent weeks.

Amit Shah, India’s home minister, told the Indian Express newspaper that he was “concerned” about the variant and the “surge is mainly because of the new mutants of the virus”. But he was “confident we will win” over the disease and said there was not yet a need to impose a national lockdown.

Bed shortages in India have forced authorities to re-establish emergency coronavirus hospitals in banquet halls, train stations and hotels that had been shut down following the previous peak in September. Crematoriums in the state of Gujarat and Delhi are running 24 hours a day, while cemeteries are running out of burial spaces.

Coronavirus patients have also been struggling to access medicines. More than 800 injections of remdesivir, an antiviral drug commonly used in India as part of Covid-19 treatment, were stolen from a hospital in Bhopal, Madhya Pradesh, at the weekend.

India is also facing a vaccine supply crunch and has frozen international exports of jabs to meet domestic demand. New Delhi pledged on Friday to increase monthly production of Covaxin, a vaccine made by Indian manufacturer Bharat Biotech, to 100m from 10m by September. The government also said last week that it would fast-track the approval of foreign vaccines in an attempt to boost supply and cleared Russia’s Sputnik V for use in the country.

The majority of the more than 120m Indians that have been vaccinated have received the Oxford/AstraZeneca jab manufactured by Serum Institute of India, the world’s largest manufacturer. The Serum Institute has struggled to increase its monthly capacity of more than 60m doses a month due to a fire at its plant earlier in the year and equipment supply shortages from the US.

Additional reporting by John Burn-Murdoch in London





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The limits of China’s taming of tech

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The record fine handed out this month to Alibaba, the Chinese ecommerce giant, was a welcome step toward combating anti-competitive behaviour. The $2.8bn penalty put Alibaba and other tech companies on notice that creating siloed fiefdoms designed to trap customers and merchants within their ecosystems will not be tolerated.

It was addressing a longstanding problem. Many of China’s ecommerce companies operate “walled gardens” that prevent interactions with rival platforms. For example, Alibaba’s Taobao ecommerce app keeps users from paying for goods using the payment app of rival Tencent. Tencent’s social media app, WeChat, prevents clips from being shared directly from ByteDance’s video-sharing app. 

Last week China’s internet and market regulators signalled the seriousness of their intent. They gave tech companies one month to fix anti-competitive practices, telling them to conduct “comprehensive self-inspections” and “completely rectify” problems, following which they would need to publicly promise to abide by the rules. The aim is create a commercially open and competitive internet.

It is tempting to argue that regulators in the west could take a leaf out of China’s book. But to hold China up as an example of competitive best practice would be to ignore the elephant in the room. Although Beijing is giving its monopolistically-minded internet companies — which are almost all private enterprises — a rap on the knuckles, it shows no sign of applying the same standards to vast swaths of the economy that have been dominated by state-owned giants for decades. 

The market dominance of these behemoths of state capitalism is an issue that affects not only domestic competitors but also foreign multinationals that operate in China. A trenchant joint paper last week from the European Council on Foreign Relations, a think-tank, and the Rhodium Group, a consultancy, took aim at the increasingly unfair advantages that this system gives China.

While it is true that China has opened up sectors such as financial services to foreign capital in recent years and allowed foreign brands to win market share in luxury goods and pharmaceuticals, broad sectors of the economy remain fully or partially closed or to overseas investors. 

Often the barriers erected to block or stymie competition are informal. Authorities can deliberately favour domestic companies in public procurement, are more ready to grant approval for licenses, subject foreign firms to arbitrary inspections or require them to re-engineer products to meet idiosyncratic domestic standards.

Such drawbacks are not new. But they are taking on an extra urgency as Chinese companies become leaders in an increasing number of industries and the country’s technological prowess draws level with the US and Europe in a list of industries. The key problem now, says the ECFR/Rhodium report, is that Chinese multinationals are using the advantage of a protected home market to build up resources that they then deploy in competition with western counterparts abroad.

This sets the scene for friction. China should extend its anti-monopolistic scrutiny from its own privately owned internet companies to several state-dominated sectors of its economy, taking care to open to foreign multinationals as much as domestic competitors. If it decides against doing this — as is likely — it will be furnishing Europeans and Americans with ammunition to argue against extending access to Chinese corporations in their own markets.



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