Chinese overcapacity at bankrupt state owned companies

Many people looking for a deep recession in China may be correct in their reading of the economy, but may not see the results if China manages to bury the cost of it. Costs will be paid, but the government may be able to paper over the differences the way it did in the last recession, when it lowered deposit rates and increased loan rates to recapitalize banks. Consumers paid for the last recession via financial repression and low interest rates caused Chinese to save more of their income, so as to afford school tuition or a down payment on a home.

China pays high price to spare state firm from bankruptcy
The Chinese official was adamant the city of Weifang would keep its rayon factory open, noting that local authorities had just stepped in to help the plant's owner repay $60 million in commercial paper.

The bailout averted what would have been China's first ever bond default and was good news for domestic bond investors, who were reassured that in China even mid-sized state-owned firms can count on "too-big-to-fail" treatment.

But for the long term, the opaque, politically driven rescue of Shandong Helon Co (000677.SZ) bodes ill for a country that must rely heavily on small, private-sector firms for future growth, as investments in infrastructure and basic industry yield diminishing returns.
Economic reform aims to grow the private sector, but state-owned company bankruptcies probably won't happen unless the economy starts growing.

If the economy doesn't grow, and Chinese governments refuse to allow state firm bankruptcies, then what of China's true debt level? If there is a serious recession, the rising costs could eventually overwhelm the central government's ability to control them.
It would have been difficult for Helon or the Weifang authorities to negotiate any arrangements with Helon's bondholders, who unlike the locally based bank creditors were a diffuse group of investors from around China whom city officials would find difficult to persuade to accept a delay in payment on the commercial paper.

A better solution, from the government's perspective, was to take care of the bondholders immediately, while pressuring local banks to be patient, analysts say.

But a long-term solution to Helon's troubles - a takeover by a stronger state-owned firm - has eluded Weifang officials.

They have been using short-term management agreements with would-be rescuers and ad hoc cash injections in the meantime to maintain production and keep workers employed.

Another timely moment for Hugh Hendry's "Confucian" aphorism:

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