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On market reform, China can’t have it both ways

China's leaders cling to the belief that they can engineer a soft economic landing. They'll just gently let the air out of urban property bubbles and fix what ails the overheated credit market with financial reforms, limited bond defaults and a fresh clampdown on shady lending practices.

Their aim is to keep everything as controlled and orderly as possible while ensuring the economy can still create enough new jobs to keep social unrest from worsening. But the messy antics of free-market capitalism keep getting in the way.

"We believe we have the ability – and all the means – to ensure that economic growth will stay within a reasonable range this year," Chinese Premier Li Keqiang insisted during his annual, tightly controlled press briefing Thursday. This came after data showing industrial production, exports, retail sales and investment had plumbed lows not seen in years, indicating a significant slowdown is under way.

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Mr. Li also acknowledged that investors could expect further defaults on bonds and other financial vehicles, but insisted these would pose no systemic risk to the broader financial system. That will require some remarkable engineering, considering how interwined some corporate borrowers are with lenders operating in the vast shadow banking network, as well as regional governments and financial institutions.

In some cases, heavy corporate borrowing stems directly from government policies designed to boost production in certain industries and force out private operators that could not reach certain size thresholds. Cleaning up the ocean of bad debt that has flooded the Chinese market (where corporate debt amounts to just over 100 per cent of GDP, more than double Canada's total) will require more than a little micro-surgery on a few insignificant basket-cases.

Last week, Shanghai Chaori Solar Energy Science & Technology Co., a middling, privately-owned solar equipment maker, made history of sorts with the first domestic corporate default in modern China, after it became clear that the financially battered company could no longer count on its friends in local government to bail it out. The failure had been signalled well in advance, and there was no doubt that it was only the first casualty of a deliberate change in public policy.

Indeed, a more important shoe soon dropped. Haixin Steel, a failing producer in northern China, defaulted on bank loans, with much wider fallout. Haixin ranks far down the list of Chinese steel makers, and it has been plagued by scandal, excessive debt, heavy losses and a dreadful environmental record. Banks had already cut off its credit lines and BHP Billiton stopped selling it iron ore in 2012.

But as the Financial Times reports, Haixin has been deeply involved in messy relationships with coal producers and the shadow-banking industry as a lead investor in a credit-guarantee outfit that earns its money as a backstop for debts of other companies. These guarantors are in no position to withstand a string of defaults.

A controlled release of financial helium looks good on paper. But the bubble-deflating process is never that simple or limited, as Premier Li and his colleagues are about to discover.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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