BEIJING -- The Chinese financial industry appears to be embracing the idea that the policy of rescuing troubled companies must change in order to instill a measure of market discipline.
Defaults on certain investment products should be allowed, former Bank of China President Li Lihui said in an interview Monday.
Many market watchers think that the government may have already changed its approach to businesses on the brink. Last Friday, Shanghai Chaori Solar Energy Science & Technology failed to pay interest due to bondholders, triggering the nation's first corporate bond default in recent history. It happened amid this year's session of the National People's Congress, a time when the leadership normally tries to avoid any potential for social unrest.
Critics say bailouts by the government and lender banks have invited moral hazard on the part of investors and made it easy for companies to finance excessive capacity. Many see the threat of default as a way to restore the discipline that comes with the possibility of failure.
China should "return to its original principle of rescuing what can be rescued and not rescuing what cannot," Li told reporters.
But the shadow banking sector links retail investors, banks, corporate borrowers and the government in complex webs. A single default could lead to an unforeseen credit crunch, choking economic growth in the short term. Provincial governments are also reluctant to see local companies go bankrupt, for fear of rising unemployment and other potential causes of social instability.
Anxiety over default appears to affecting credit growth. Total social financing -- a broad measure of credit availability published by the People's Bank of China, the central bank -- came to 938.7 billion yuan ($153.1 billion) in February, down 131.8 billion yuan from a year earlier. These flows, which include bank lending and issuance of corporate bonds and trust products, had been rising rapidly.
While bailing out troubled companies may spare short-term economic pain, allowing murky lending to go unchecked could create increasingly unmanageable longer-term risks. Navigating this dilemma poses no easy challenge for China's leadership.
On Monday, the benchmark Shanghai Composite Index fell 2.86% -- its biggest drop since last June -- to 1,999, slipping below the psychologically important 2,000 level. The yuan briefly dipped 0.5% against the dollar in overseas trading.