In a paper, titled China reforms stall at crossroads, AllianceBernstein laid out three recent developments in China's corporate sector that should give investors pause.
First, AB pointed to a default on an interest payment on a privately-placed RMB870 million bond issue by a majority state-owned enterprise (SOE) steelmaker, Dongbei Special Steel (DSS).
Defaults on interest payments are nothing new in China, said AB – there have been 18 since 2014 – but in the case of DSS, bondholders have called on regulators to suspend funding from the provincial government.
"This presents the central government with a dilemma: should it help the provincial government to rescue the company, or should it allow DSS to fail?" said AB.
"In light of these undesirable alternatives, the government may choose to do nothing — and this is one instance where we see the potential for policy indecisiveness to increase the risk of economic drift."
Another example cited by AB is the potential US$204 billion merger of Shenhua Group, China's biggest coal power company, with China General Nuclear Power Group.
There has been a series of SOE mergers in 2016, but business logic has played "little part" in them, according to AB.
"Instead of reducing the SOEs' economic dominance by redistributing their resources to the private sector, letting weaker ones fail and keeping ownership of strategically important entities, the government appears merely to be conducting a crude mathematical rationalization of the sector with no view to broader reforms," said the paper.
Finally, AB highlighted the increasing amount of leverage among Chinese listed companies which, given the sluggish state of the economy, appears to make "little sense" and creates a sense of ambiguity.
"China’s policy makers are at a crossroads and seem reluctant to move forward," said AB.
"Instead of acting in the case of DSS, for example, and modernising and clarifying the laws relating to corporate solvency (and perhaps allowing some companies to fail), they appear to be biding their time; instead of opening the SOE sector to private enterprise, they appear to be rationalising it and bringing it further under Party control.
"All this spells uncertainty for investors, and the longer such uncertainty lasts the greater the risks will become," AB said.
"This applies to cashed-up Chinese companies as much as to global bond buyers: it may be only a matter of time, for example, before China’s policy inertia and its companies’ investment in financial instruments creates a dangerous combination of low economic growth and financial volatility."
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