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China is grappling with a ‘devil’s bargain’

It has about $330 billion of liabilities and, along with the bad debts it was supposed to manage, a disparate collection of businesses and other assets it had acquired in a spending spree well beyond its original mandate. Its chairman, and the architect of its expansion, was found guilty of corruption and executed in January.

There have also been a string of other defaults and threatened defaults among Chinese state-owned and private entities over the past year or so – yields of China’s offshore high-yield bonds have been trading at double-digit levels – but the other “whale” in trouble is one of China’s biggest property developers, China Evergrande.

With most of China’s house wealth tied up in property and Evergrande one of the country’s largest developers its struggles are of national significance and concern. It has been engaged in a firesale of assets that has reduced its debt load from a peak of about $180 billion last year to about $120 billion but it has total liabilities – including trade creditors – of more than three times that amount.

HNA, Huarong and Evergrande are almost certainly the tip of an iceberg, with the continuing attempts by Beijing to deleverage and restructure its largest enterprises an indication of the perceived/real fragility and vulnerability of the corporate sector.

Its warning that it might default on its debt on Tuesday sent shudders through offshore bond markets – its bonds are trading at less than 40 cents in the dollar – where the company has been China’s biggest issuer of junk bonds. More than 40 per cent of its debts fall due within the next 12 months.

The authorities wouldn’t have been taken by surprise. They directed property developers to reduce their leverage and stop issuing new debt last year and called in Evergrande last month to put pressure on the company to stabilised its finances without destabilising financial and property markets.

There has been speculation of a state-led bailout of Evergrande – which underscores its significance within China.

This year it has become clearer why the authorities were so focused on deleveraging as the dire financial condition of some of China’s biggest enterprises has been revealed.

This year it has become clearer why the authorities were so focused on deleveraging as the dire financial condition of some of China’s biggest enterprises has been revealed.Credit:Bloomberg

Despite the interventions in Huarong (where the majority shareholder, the Ministry of Finance, made it almost inevitable) and HNA – the authorities would, however, be reluctant to bail out yet another over-extended group and add to the moral hazard already pervasive in an economy so state-dominated.

HNA, Huarong and Evergrande are almost certainly the tip of an iceberg, with the continuing attempts by Beijing to deleverage and restructure its largest enterprises an indication of the perceived/real fragility and vulnerability of the corporate sector.

The examples of threatening corporate recklessness and ill-discipline, along with the hubris and conspicuous wealth and prospective power of the billionaire tech entrepreneurs – China has more billionaires than any other country – would almost certainly have unsettled the authorities and have contributed to the crackdown on the big tech companies and the shift in broad national strategy from creating wealth with an expectation that it would trickle down to redistributing it.

In the West there is a phrase that encapsulates the dilemma confronting the Chinese authorities in dealing with the likes of HNA, Huarong and Evergrande and which fits neatly with the new emphasis on common prosperity.

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“Privatise the profits, socialise the losses” is essentially the devil’s bargain the most indebted of China’s big companies have presented Beijing. That’s a difficult enough proposition to swallow in a free market economy. It’s a near-impossible one within a communist one, even one with a model of “socialism with Chinese characteristics.”

It would seem the authorities have redefined the model, adding a lot more socialism and reducing the “Chinese characteristics.”

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