BEIJING • China’s campaign to reduce debt and instill corporate discipline is reshaping the US $ 12 trillion (S $ 16 trillion) credit market.

One of China’s most prolific debt issuers hasn’t sold a single dollar of bond in one year and five months, the longest drought since 2013. Investment-grade conglomerate owned primarily by the government, it faces a liquidity shortage in a test of state support. Analysts from UBS Group and Goldman Sachs Group now say that the notion of “too big to fail” no longer applies in China, because defaults this year exceed 23 billion dollars, a record amount.

Beijing is taking advantage of the strengthening economy and the stability of financial markets to harden its corporate sector. The result is a reassessment of risk that should discourage the kind of reckless debt-fueled expansion that has inflated some companies to dangerous size. The emergence of such bloated empires has created a threat to the financial system as well as a challenge to Chinese President Xi Jinping’s grip on power.

Ending the practice of allowing risk-taking by indebted giants such as China Huarong Asset Management and China Evergrande Group while they are immune to potential consequences would make the financial system more resilient in the long run, but a major defect would eventually lead to pain.

“The government has become more comfortable with defaults… but Huarong and Evergrande present much bigger and more systemic challenges,” said Professor Jeffrey Chwieroth, who specializes in international political economy at the London School of Economics and is a co-investigator at the Center for Systemic Risk. “Deleveraging and eliminating the prevalence of government guarantees can lead to unwanted consequences and market panic.”

For the Communist Party, which celebrates its centenary next week, inaction is no longer an option. Officials repeatedly warn of the risks of a bubble after last year’s monetary and fiscal stimulus pushed economic debt to a record high. The change was visible in last month’s credit data, which showed corporate bond issuance was contracting the most in four years.

The problems associated with over-indebted conglomerates are piling up. HNA Group, a little-known airline operator that grew into a sprawling giant before collapsing, faces some 1.2 trillion yuan (S $ 250 billion) in claims from its creditors, Bloomberg News reported this month. The group has spent more than US $ 40 billion on acquisitions on six continents as of 2016.

One of China’s biggest defaults last year was Tsinghua Unigroup, which had ambitions to be the country’s first giant in the global semiconductor industry and had already forecast an offer of 23 billion dollars for the US memory chip giant Micron Technology.

These companies were in many ways emblematic of China’s growth in the years following the global financial crisis. Authorities unleashed a stimulus blitz that fueled a dizzying economic expansion with a credit frenzy. Concerns over the scale of the country’s debt mountain and the possibility of a “Minsky moment” prompted Xi to launch a deleveraging campaign in 2017, before putting it on hold during the trade war with the United States. United. The Minsky moment refers to the onset of a market collapse brought on by reckless speculative activity that defines an unsustainable bullish period.

With Mr. Xi renewing his drive to reduce debt, the real estate sector has become a major target. The government has previously said it has drafted new funding rules for the industry, which accounts for around 29% of economic output.

Evergrande has pledged to meet at least one of these borrowing limits, known as the “three red lines,” by the end of this month. The company is ramping up asset sales as it seeks to reduce its $ 100 billion burden. Evergrande has not sold dollar bonds since January last year and its rating was further downgraded this week by Fitch Ratings.

Another focus has been the bad debt management sector, which is responsible for cleaning up bad loans from China. A key player is Huarong, who found himself embroiled in a financial scandal under his former chairman before his arrest in 2018. After Lai Xiaomin’s execution this year for corruption, concerns about the company’s future have grown. intensified when it did not publish its 2020 results in March.

Beijing’s silence on its plans for Huarong has left some of the company’s longer-dated bonds trading at stressed levels. Huarong and its subsidiaries have assets of US $ 39.8 billion.

Businesses are under scrutiny more than ever as Mr. Xi enters a critical period in his reign. In the past year, the Chinese leader has doubled down on perceived threats against the Communist Party ahead of a leadership reshuffle next year that could see him retain the presidency for a third term.

Beijing has tightened regulations on corporate giants like the Alibaba group and Tencent Holdings, and forced high-profile entrepreneurs like Mr. Jack Ma and Meituan founder Wang Xing to keep a low profile.

Public enterprises are not spared. These and other non-private companies accounted for 54% of the value of onshore defaults in the first four months of the year, according to JPMorgan Chase & Co.

Evidence of wider market contagion has been relatively limited. Spreads of investment-grade dollar bonds over respective government bonds have tightened since reaching a nine-month high following Huarong’s missed earnings report.

But the stakes are high: an unexpected default or a painful restructuring could trigger widespread panic. While Beijing will likely step in to avert a credit crunch if it does, there is considerable uncertainty about the timeliness and extent of such support, Goldman Sachs analysts wrote in a note earlier this month. this month. UBS analysts agreed, warning investors to prepare for the disappearance of government support for state-owned companies.

“The problem with ‘too big to fail’ is that it can quickly turn into ‘too big to save’,” said Michael Pettis, professor of finance at Peking University. “Since the financial crisis, China has maintained stability by suppressing risks. She can’t do it forever.

BLOOMBERG