Fuguiniao, a Hong Kong-listed shoe and garment manufacturer, recently became the fifth mainland Chinese company this year to default on its bonds. Like many other companies that have been unable to repay or refinance their debts, Fuguiniao had embarked on an overly ambitious expansion plan. Its financing costs rose by two percentage points as profits turned into losses in the first half of last year, according to data from Mizuho Securities Asia.

Unfortunately for China, Fuguiniao is far from alone. "Policy driven deleveraging is causing difficulties," said Christopher Lee of Standard & Poor's Financial Services. "Higher funding costs could tip some companies into distress that depend on refinancing to roll over their debt." In the first six months of 2018, Chinese companies defaulted on 18 publicly traded bonds, compared to 23 in the whole of 2017, according to Gavekal, a Beijing-based research company.

Many more defaults are likely in the near future. In the three years to 2021, debts amounting to 11 trillion yuan will become due in China, along with another $215 billion in dollar debt issued offshore, according to S & P.

Not long ago, such corporate defaults were considered a good thing. They were taken as a sign that Beijing was determined to rein in the debt of zombie companies as part of its efforts to reduce leverage in the financial system. The campaign began at a time when the macroeconomic outlook was fairly benign, and the economy could afford to take the pain of slightly slower growth.

Today, though, the increase in defaults is adding to macroeconomic uncertainty, especially when combined with fears about the potentially negative impact of U.S. trade demands on growth, the stock market, the balance of payments and the currency. Moreover, disagreements about how to respond to Washington have exposed cracks in what had been a solid consensus on policy pronouncements, adding to the uncertainty.

Hong Kong-listed Fuguiniao became the fifth mainland Chinese company to default on its bonds this year. There will likely be more.   © Imaginechina/AP Images

Even normally staunch defenders of Beijing's policies are voicing criticism of the policy zigs and zags as China seeks to reduce the growth of debt while not killing off the credit that enables companies to grow. "The deleveraging has been indiscriminate," said the mainland Chinese head of a private equity firm with offices in Hong Kong and Beijing. "It is all about micromanaging, and stopping lending by decree. It is also too late. They should have intervened 'before the rice was cooked.'"

Amid a host of policy announcements over the past two weeks it appears that Beijing has veered away from its tough stance on deleveraging to support growth more aggressively. A series of policy initiatives will make credit more easily available as the government seeks the right balance between discipline and credit-fueled support for companies -- whether in the private or state-owned sector.

Difficult trade-offs are involved, though. If the easing is insufficiently substantial, the number of defaults will soar, leading to contagion in the domestic equity and debt markets and potentially spooking both. But if the easing is excessive, the yuan will drop against the dollar, which is being buoyed by rising rates in the U.S. That would make life difficult for Chinese companies that have borrowed offshore to repay their dollar borrowings.

Moreover, if the market begins to believe that the Chinese currency will depreciate, capital outflows will accelerate. Expectations of a 5% fall would be enough to trigger outflows of $375 billion, according to calculations by JPMorgan, possibly triggering a vicious circle in which yuan weakness encourages capital outflows, which further weaken the currency. "Short term outflows... and services payments, which arguably disguise some capital leakage, have risen ominously," economists at JPMorgan said in a report on July 20.

A cut in the People's Bank of China's reserve rate, which took effect on July 5, was the first signal of the shift in policy. That was followed on July 23 by news that the central bank would make funding from its medium-term lending facilities available to banks to help finance their purchases of corporate bonds -- the lower the quality, the higher the funding available.

Many analysts think a more forceful fiscal policy response would be more effective, arguing that more measures along the lines of recent commitments to higher investment, cuts in personal income tax and subsidies for corporate spending on research and development, would do more to support growth.

The debate about the merits of fiscal and monetary policy is not merely theoretical. It comes at a time when Beijing is elevating state control over markets, and is as much about political infighting and ideology as the best response to financial uncertainty. It is also being conducted largely in whispers -- unlike the increasingly strident tone of discussions about trade frictions.

Many Chinese believe that Washington's demands are more about geopolitics than trade, reflecting the rising power of China and the declining global influence of the U.S. Some in Beijing are saying that American demands for structural reforms impinge on Chinese sovereignty in ways that are reminiscent of treaties on trade and Hong Kong enforced by British naval power almost two centuries ago.

The resentment is understandable. Still, U.S. pressure on trade has been effective in unintended ways, revealing China's wider vulnerabilities -- just as the British military did in the 19th century. Now, as then, not all of those weaknesses can be blamed on the outside world.

Henny Sender is the Financial Times' chief correspondent for international finance, based in Hong Kong, and contributes occasional columns to the Nikkei Asian Review.