Saturday, 15 March 2014 00:00

Shanghai Chaori Default Signals Shift to Liberalization of Chinese Markets

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Chaori rose a lot of attention in financial circles as being the first corporate bond default in Chinese history, but for the solar industry, this is just system at work

 It was a summer of 2012 when Wenzhou was hit by another bankruptcy wave due to lack of financing, recession, and less familiar to Western world, power failures. Wang Deyang, the party secretary of Guangdong province, which was also struck a couple of times with bankruptcy waves, was opposed to Wen Jiabao's, the six Premier of State Council, and Wang Qishan's, the member of the Standing Committee of the Politburo, bailout policies. Jiabao and Qishan disregarded Deyang's opposition, and went on injecting money into the failing companies, under the pretense of government's support for small and medium size enterprises (SME). Southern Weekend and Yijing Magazine, which were extensively covering this topic discovered that China did not even have funding for SMEs, and what is even more powerful, Chinese government never even considered having such a financial assistance. Nevertheless central government stepped in to promote solar industry, but not with the intention to protect small or medium enterprises. Xi Jinping was about to be elected, and the party elite wanted quiet and soothing power shift.

Recently most of the media speculated on whether Shanghai Chaori Solar Energy Science & Technology Company, a one of many solar manufacturers in the country, will default on its bonds or will be saved by the local or even perhaps central government. Since National Party Congress and Party People's Consultative Conference were underway, the expectation was that the party would not allow for it to avoid a shadow over party's ability to control the country and its economy.

However, when it comes down to momentous meetings, Chinese Communist Party, as always, is about sending clear messages. Long before Chaori trodden into its faith, China's regime sent a message of liberalizing its financial markets. One time provincial secretary Wang Deyang, who oversaw bankruptcies as a tool to identify strong from weak, has entered Politburo and was serving as a vice premier.

The Cull List

It is even stranger to see local analysts, and globally, Reuters and Bloomberg to be surprised with Chaori's demise and not to read other signs.
Recently, Chinese government published a selected list of solar companies, meeting technological, regulatory and research and development criteria set by the government. In return government recommended those on the list for funding by the state banks; ask for participation in public project bidding and so on. All perks Beijing was willing to provide for years, apparently to anyone, now became available only to a few.
On the list are the biggest US-listed Chinese companies: Yingli (NYSE: YGE Canadian Solar (NASDAQ: CSIQ), JinkoSolar (NYSE: JKS), Hanwha SolarOne (NASDAQ: HSOL), JA Solar (NASDAQ: JASO) and Trina Solar (NYSE:TSL). The ones, not on the list as media specialized in green and clean energy reported are left on their own in the markets. By definition, they will have a hard time finding funding for their projects, and more importantly will lose tax incentives on exports. Some 350 companies will either leave solar business or become a part of bigger companies.

While some analysts focus their attention on the structure of the list showing 44% percent of companies manufacturing poly-silicon/ingots, 16% percent manufacturing wafers, 39% percent manufacturing cells, and 26% percent being module assembly, IHS published that some 70 companies with their 109 subsidiaries representing 92% of the nation's poly-silicon capacity, 94% of wafer capacity, 95% of PV cell capacity and 93% of module capacity.

Others still see an opportunity for small PV suppliers to work with the help of the first in China five private banks, but the reason why most of the analysts are skeptical of survival was best described by former COO of J.P. Morgan in China, Carl Walter.

"Unlike SOEs and large private enterprises that are prime sources of local GDP growth, SMEs are never "too big to fail". The non-performing loan ratios of small and medium enterprises in 2009, for example, were 6.0% and 2.8%, much higher than the national overall of 1.58% at the end of 2009. Foreign banks have made little headway in funding SMEs despite the fact that many have eyed SMEs since their access to China. It's just not practical to lend to these guys," says Walter.

Grasp the big and release the small

The reason for this kind of conduct by the banking sector in China is found in the policy of " 抓大放小 ",in English definition "Grasp the big, release the small", SOE reform strategy of the late 1990s. The idea was that the state would retain control, and try to improve the operational efficiency, of a relatively small number of exceptionally large enterprises in strategic sectors such as railways, aviation, telecoms, energy and petrochemicals while privatizing most activity in consumer goods and services sectors. This strategy was successful: in the decade ending in 2008, the number of SOEs fell from 260,000 to 110,000. The private sector's share of national fixed investment rose from less than a 25% to 58%. The profitability and return on assets of state firms rose dramatically and came close to matching the returns in private firms. Finally, the percentage of SOE assets in "strategic" sectors rose to an all-time high of 62%.

Thanks to Wen Jiabao's lack of enthusiasm for state sector reform, some of these gains have been reversed. Ominously, the return on assets in SOEs plummeted to less than half the private-sector average, and state firms began to re-colonize sectors from which they had previously retreated: by 2011, half of SOE assets were in these non-strategic sectors.
Now, the reformers are back in control and aim to complete the 抓大放小 objective. This does not mean eliminating the state sector, or privatizing the core centrally-owned firms. It means a determined push to scrap non-core SOEs and assets, abandon consumer sectors in favor of private firms, and improve the operational efficiency of the remaining SOEs.

When it comes to the solar market in China, the government will continue to promote the biggest companies in the market and at the same time hope for SMEs to find the method to survive based on the individual talent and not state funds. As a result, China is finally getting rid of its redundant suppliers, turning to its own demand for solar energy and giving the big, the big portion of the business.
In the landscape of restoration and the desire for free market; critics fueled a sense of unease about the ability to get reciprocation of objectives between central and provincial governments. Governments of Wuxi and Jiangxi provinces by supporting former glory skeletons of Suntech and LDK Solar, confirmed to that side of the argument, that ideas are not aligned. However, the assessment of those actions done by optimists suggests substantial differences. Both companies were never considered small. Suntech was the largest Chinese solar company globally at one time. The sense of discomfort locally and on the international arena played a different theme and caused different events versus Chaori's default including dealing with the fallout of delisting on the US markets.

Liberal Market and Planned Economy

Each year, local governments have quotas to fill. If they do not meet these quotas, central government cuts the funding. If they do, they get more funding. Since localities run less than half of state revenues, but at the same time are responsible for 85% of government expenditures, local government offices often resort to a variety off-budget funding schemes. Some of the most popular ones are land and real estate developments, but recently green energy projects are gaining attention.

When adding up severe lack of regulation and transparency, experts are worried about local government's lack of discipline. After taking one look at real-estate market, where the central government tried three times to prevent the rise of real estate prices, but all three times failed to do so, there is a doubt on the ability to maintain provinces accountable to centrally created policies.

No matter what for US-listed Chinese solar companies, Chaori's bond default and current Tianwei's bond and stock suspension promises future benefit from central government policy of consolidation and exports qualifications. Both defaults are part of implemented policies and do not spell disaster for any of the six leading names, contrary to a portrait painted by Western media. Chaori disappeared from exports and Tianwei will have a hard time to stay with it inconsequential contribution. Curiously Chaori's name appears on the cull list, which could cause a lot of things, but certainly one is how serious central government is about its plans.
The largest threat to stability and expediency of sorting out solar industry is not the number of future defaults, but local government's desire to continue with own policies, which could possibly contend with ones promoted by Beijing.

Read 4165 times Last modified on Wednesday, 14 May 2014 20:59
Dalibor Petkovic

Dalibor has more than ten years of experience in linguistics and media industry. He spent two years working as an editor and consultant for Chinese state radio ‘’China Radio International’’, before getting tired of Chinese media system.  These days he works as a partner at Zhou & Petkovic linguistics’ consulting firm based in Zhejiang, PR China. He resides in Jinhua, PRC.

SPVInvestor Research, a Canadian incorporated research firm. We publish CEDR, the most complete, monthly report on exports of modules, cells, wafer from China, including focus on US-listed Chinese companies.