As China slows with a receding credit tide, its titanic armies of naked swimming businesses are exposed. So far, the headlines have been hogged by Huarong and Evergrande but there are many other defaults and the potential victims in opaque Chinese debt daisy chains are limitless.
This is one reason why I do not expect China to enter an acute financial crisis. Rather, these irresolvable debts will drag the entire economy down over time into a bog of slow growth as bad debt is rolled over forever.
That said, we do go through these periods of reform that threaten instability and possible crisis. So where are we now? Goldman has more:
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- China credit concerns have returned to the forefront in 2021, with the sharp underperformance in China HY. To us, the underperformance is due to the repricing of tail risk, reflecting market expectations of higher defaults among the riskier credits.
- The repricing of tail risk appears to be largely contained among lower-rated property developers. This is in line with the default pattern so far this year, with 78.1% of China HY defaults this year from property companies.
- We believe that contagion risk may be contained. We maintain the view that, despite tighter regulations across different segments of the Chinese economy in recent months, an equally important policy objective is to ensure that systemic concerns do not emerge.
- We remain positive on Asia HY. That said, for China HY, we prefer shorter-dated maturities (to reduce price volatility) and higher quality names (to reduce credit volatility). Carry is important, but the repricing of tail risk among China HY will likely continue to be a major theme.
That’s a reasonable base case. Note that the property focus is still not very good for bulk commodities. There will be a crisis there, anyway.