Xi Jinping delighted investors when, as China's new leader, he pledged in 2013 to let market forces play a "decisive role" in Asia's biggest economy. He may soon have a chance to match his words with deeds.
The now-embattled HNA Group was barely a blip on the Communist Party radar when Xi took office. In the years since, the Hainan-based conglomerate has carved out a role as one of China's splashiest dealmakers, gorging on everything from Deutsche Bank to Hilton Hotels to Uber as the embodiment of China Inc.'s global ambitions.
Now it is making headlines for all the wrong reasons: possible default or even collapse.
The reports emanating from HNA are deeply troubling, including its units missing bank payments and asking employees to forego wages in lieu of promises of bigger paydays later. Such stunts have resulted in a sort of financial death march among analysts.
UBS, for example, fears a post-default surge in funding costs for high-yield issuers that could slam Chinese property companies and the broader junk bond market. Analysts at HSBC and Lombard Odier are more sanguine about systemic risks, should HNA renege on $13.7 billion of dollar debt or $100 billion overall.
But who really knows? Xi's remarks on market forces belie a tantalizing paradox about modern-day China. For all the talk about a "new normal" for economic policy, China is becoming more and more of a black box. Xi's crackdown on journalists, the internet and smartphone texting is muddying the picture and making it harder to police shenanigans in shadow banking circles and on corporate balance sheets.
HNA is a timely microcosm of China's challenges -- and a conundrum for Xi's capitalist bona fides. The impulse might be to save HNA. The impetus to avoid negative headlines may increase ahead of next month's National People's Congress, Xi's annual chance to tout China's rise. But Beijing should do the opposite and let this overextended conglomerate go bust.
Granted, HNA may still be able to work out its debt troubles. It is frantically trying to raise cash. Late last month, HNA told creditors it is working to sell some $16 billion of assets to stave off a liquidity crunch. Even so, markets are abuzz with default fears.
Letting HNA go bust would send the right signal, backing up Xi's words in 2013. As Japan continues to demonstrate, making an economy more efficient, productive and flexible means letting markets, not bureaucrats, decide whether conglomerates live or die.
HNA encapsulates so much of what went wrong with the China that Deng Xiaoping envisioned in the 1970s and 1980s. It features a murky corporate structure not unlike China's state-owned enterprises. One of its main creditors is state-controlled China Development Bank. It came out of nowhere -- a resort island of all places -- and inexplicably amassed epic debts. And it has maintained a veneer of stability as trading in some of its listed entities halted and borrowing costs rose.
This highlights one of Xi's biggest challenges: steering the flow of money away from corporate zombies denting China's productivity and imperiling the outlook. Xi's first big chance to show a tolerance for the Joseph Schumpeter-like creative destruction needed to rebalance the Chinese economy came in 2015. In July and August of that year, Shanghai shares went into freefall. Over a three-week period in that July alone, the market lost 30%. Rather than let prices settle on their own, Xi's government commandeered capitalism.
As the People's Bank of China slashed borrowing costs, regulators eased leverage limits, loosened margin trading rules, suspended initial public offerings, let punters put up homes as collateral, and halted trading in about 1,400 companies. Xi's government even underwrote a massive public relations blitz to encourage mainlanders to buy stocks out of patriotism.
Saving HNA would exacerbate China's moral hazard troubles. The reasons why Xi would step in are clear enough. In recent years, globally acquisitive conglomerates HNA, Anbang Insurance Group, Dalian Wanda Group, Fosun Group, Zhejiang Luosen Neili were sources of pride. If HNA unraveled, it would tarnish efforts to cultivate national champions, undermine domestic bank balance sheets and dent growth in local economies, like Hainan, that most need it.
China's debt troubles hit the headlines on Friday when the government suddenly grabbed control of Anbang, an unprecedented seizure of a private insurer. While it spoke to Xi's determination to curb runaway debt and overseas expansion, the act was the antithesis of a market solution. Granted, it sent a message dear to Xi's heart: When you deal with a mainland conglomerate, you are in business with the Communist Party. But it raised fresh concerns.
The move smacked of desperation, suggesting Anbang's balance sheet may be even riskier than markets understand. It is sure to feed political intrigue in a variety of directions. Anbang founder Wu Xiaohui, facing charges for alleged fraud, had been trying to increase political ties in the U.S. In November 2016, he even met President Donald Trump's son-in-law, Jared Kushner, about a stake in a Manhattan building. Bottom line: Xi has just invited dozens of questions but offered no answers.
There are other global risks concerning HNA. Its outstanding dollar bonds account for more than 1% of Asian high-yield debt outside Japan. Hence UBS's concern that a default could push Asian junk bond spreads upward by between 160 and 240 basis points over comparable government securities. Adding to the uncertainty: a new Federal Reserve chairman in Washington. Markets worry Jerome Powell might tighten credit more aggressively than his predecessor.
Yet the cost of saving HNA in the long run would be high. Marshalling public resources to head off embarrassment or short-term turmoil would set back efforts to produce a more efficient economy. Cleansing China's financial system will be destabilizing and painful. But ending the perception that one-time national treasures like HNA are not too big to fail is vital to stopping the flow of money to unproductive pursuits. That goes too for management teams rolling the dice assuming Beijing will save them.
The more leverage Beijing tolerates in the name of rapid growth and market calm, the bigger China's imbalances grow. Xi must choose between giving markets a decisive voice and making China Inc. too big to save. With HNA, he can prove he favors markets once and for all.
William Pesek is a Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He has written for Bloomberg and Barron's.