China | To bail or not to bail? Understanding the logic behind Chinese-style deleveraging

Summary

With the economic recovery becoming entrenched in the aftermath of the Covid-19 pandemic, China’s authorities shifted their focus to containing the overall leverage. This report focuses on the latest development of firms’ default to understand the logics behind the authorities’ decision to selectively extend their support.

Key points

• Key points:
• China's deleveraging is proceeding in four phases. The latest stage of China's deleveraging started in the aftermath of the Covid-19, a series of credit events including Huarong Asset management Co. and property developer Evergrande have sent severe shocks to both the offshore and onshore markets.
• Huarong’s case reflects the authorities’ concerns of systemic risks. Although introducing strategic investors could help Huarong to honor its debt payment in the short term, it is still possible for those debt holders to accept a certain haircut of their holding debt in the long run
• Evergrande is not “too big to fail”. Although the market gave much stronger reactions to Evergrande than Huarong, we don't believe that the authorities will bail out Evergrande as they did to Huarong for a number of reasons
• Pursuing an orderly deleveraging is more art than science. The authorities will selectively bail out their favorable targets from a pool of distressed companies. We found some patterns after summarizing the default cases by company classification.

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