While the macro watchers were keenly awaiting China's macroeconomic data dump on Sunday night, which was far worse than reported (as we will show shortly), a just as notable development was taking place in China's microeconomic world, where as the FT reported on Sunday, China's state-owned SinoSteel, the country's second largest importer of iron-ore, and a major miner and steel trader (yes, another commodity trader) was "poised to default on its bonds this week, the latest test of whether Beijing is willing to impose market discipline on national champion companies."
As the FT adds, "Sinosteel, one of an elite club of 112 state groups directly owned by the central government, sent a letter to investors last week warning that its subsidiary lacked the funds to repay principal and interest on Rmb2bn ($315m) in bonds sold in 2010 due on Tuesday."
"The company’s business has stagnated and cash flow has dried up at headquarters and a portion of subsidiary enterprises,” said the letter, a copy of which circulated on social media on Friday.
Transparency is not Chinese insolvent corporations' strong suit: "Sinosteel was not available for comment. A person who answered the phone at Sinosteel refused to transfer calls to the company’s media relations department."
None of this is a surprise: we reported nearly a month ago [11]that more than half of China's commodity producers are technically insolvent at current commodity prices (a finding which CLSA later used to back into a whopping 8% NPL for the Chinese banking sector [12]), and don't generate the cash flow to pay even the interest on their debt, let alone fund maturities!
[13]
And yet, Sinosteel's troubles, which mirror those of peer companies Glencore and Noble Group, did surprise some despite clear warnings by other: "The company has lost debt repayment ability. It can only rely on external support,” Jiang Chao, Haitong Securities bond analyst, wrote last week.
However, while China’s leadership has huffed and puffed about freeing its markets and imposing the "business cycle", even if it means a surge in default, it remains reluctant to "tolerate public defaults due to fears about financial instability. Sinosteel investors are hoping that the government or another state entity will step in with a last-minute bailout. Last month state-owned heavy machinery producer China National Erzhong Group narrowly averted default when its parent company said it would buy outstanding bonds from investors."
Sure enough, Sinosteel investors got their wish, and overnight Bloomberg reported that Sinosteel postponed the date on which investors can demand bond repayment by one month, after authorities were said to have stepped in to help the company.
From Bloomberg:
Investors can’t sell back Sinosteel Co.’s 2 billion yuan ($314.4 million) of 2017 notes until Nov. 20, after an original option date of Oct. 20, according to a company statement posted on Chinabond’s website Friday that didn’t say if investors agreed on the changes. The move comes after parent Sinosteel Corp. sent a letter to noteholders pleading with them to not sell the bonds back as Sinosteel would be unable to repay, and the National Development and Reform Commission planned to meet investors, people familiar with the matter said last week.
So much for the Politburo's stern insistence on liberalizing the market: yes, free markets are good... as long as they go up. If they go down, or a default is imminent, well that's unacceptable:
China’s President Xi Jinping is trying to rein in the world’s biggest corporate debt loads without sparking turmoil in financial markets. Defaults have mounted as economic growth fell below 7 percent in the three months through September in the slowest quarterly expansion in more than six years. In a sign of official concern, the NDRC would also ask investors in Sinosteel not to sell back the notes, one of the people said last week.
“Sinosteel probably communicated with investors and got permission for the deadline extension,” said Zhang Li, a bond analyst at Guotai Junan Securities Co. in Beijing. “It’s still uncertain if it can meet all the payment on the due date after the deadline is extended.”
Chinese credit markets also got a reprieve last week on another borrower’s debt.
Sinosteel noteholders must register by Nov. 16 to sell the securities back, according to the statement. The firm will use stock of unit Sinosteel Engineering & Technology Co. as a pledge for the bonds.
Other companies on the firing range avoided default by the skin of their teeth: "sausage maker Nanjing Yurun Foods Co., which had said earlier last week it wasn’t sure it could repay a 1.3 billion yuan note due Oct. 18 amid cash shortages, issued a statement Friday saying it would repay."
Unfortunately for China, this is the definition of kicking the can: absent a dramatic increase in commodity costs, not only SinoSteel, but hundreds of other commodity companies will be broke soon, and even the Chinese government will find it difficult to nationalize half its commodity industry:
Steel analyst Peter Marcus used the term "death spiral" to describe when the steel industry continues to run high fixed-cost assets despite mounting losses. The syndrome only ends when the pain is too great and massive amounts of capacity are shut down so that the industry can recover. The BI Chinese steel profitability index at all-time lows and Sinosteel and its regulator urging bondholders not to redeem debt are examples of the death spiral. Government intervention typically makes the spiral longer and deeper.
Ironically, Sinoesteel will now be forced to undercut prices even more to capture marginal cash flow, even if it means a further collapse in iron and steel prices, which incidentally is precisely what happened overnight when as Reuters reported, Shanghai steel futures fell more than 1 percent to an all-time low.
Bottom line: ignore the meaningless experiment in goalseeking that is Chinese official "macro" data, and focus on the micro-level cash flows. For China's real economy, and the deflationary wave that is about to sweep the globe should China proceed to nationalize everyone who is about to fail, that is all that matters.
