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China Wakes Up To Corporate Default

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Markets in Asia took a turn for the worse overnight as of the Bank of Japan’s action, or rather inaction, combined with growing concerns over China took their toll. The Nikkei suffered the hardest falling 2.6% as Japan’s latest attempt at recover looks to be in jeopardy. Most other Asian markets suffered between 1% and 2% while the European exchanges this morning gave up approximately 1% across the board.

The market is continuing to digest the latest round of data from China, the emergence of a trade deficit at the weekend has turned sentiment against the Chinese economy as it becomes evident that the authorities there are struggling to maintain the pace of growth.

To add to China’s concerns, falling commodity prices are proving a double-edged sword for Chinese corporations. On one hand cheaper raw material prices should be a boost for China’s enormous manufacturing sector, on the other hand however the lowering of value of industrial metals is causing some serious balance sheet issues for these companies. It transpires that Chinese companies often use stockpiled metals, Iron Ore and Copper in particular, as collateral in borrowing arrangements. The recent fall in prices of these commodities has caused a series of loan covenant breaches that is placing financial pressure on many of these high volume tight margin businesses.

Major corporate failures have been rare occurrences in China to date, the authorities invariably step in to protect indigenous industry. This is not an unusual step for a country to take, we have seen government intervention to safeguard strategic industry on plenty of occasion in the US and Europe. What is unsettling about the current situation facing Chinese companies is that the government appears to have revised it’s policy towards providing such a blanket guarantee to domestic businesses. In the long run this is a positive move as it will remove the ‘moral hazard’ from the equation and encourage China’s corporate sector to adopt a more modern approach to business. In the short run however there is no way to predict the scale of the problem or where the Chinese authorities will draw the line.

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