The Economist UK - 16.11.2019

The EconomistNovember 16th 2019 Finance & economics 69

I

t certainly sounds pretty powerful:

China Nuclear Engineering Construction

Group. Once controlled by the People’s Lib-

eration Army, it is now, it says, part of a

“central state-owned enterprise (soe)”, a n

elite class of firms belonging to the Chi-

nese government. Its website is full of pic-

tures of its executives signing deals around

the country. Like any good state-run giant,

it is politically correct, its statements echo-

ing Communist Party slogans. There is just

one snag: China Nuclear Engineering Con-

struction Group is not a central soe.

As China’s economy slows, defaults

have risen sharply. Such failures, though

painful, separate strong companies from

also-rans, a process other countries know

well. In China there is an extra wrinkle: the

downturn is also exposing fake soes. These

are companies that misled creditors about

their state connections to suggest they

would be supported if they ran into trouble.

But when trouble arises, the government is

nowhere to be found.

Last month Huarong, a firm that han-

dles non-performing loans, put 610m yuan

($87m) of China Nuclear Engineering Con-

struction’s assets up for sale, consisting of

property in the province of Anhui. Despite

its name, China Nuclear focused on prop-

erty, like several other fake soes. It also

benefited from confusion with a real soe,

China Nuclear Engineering and Construc-

tion Corporation (eagle-eyed readers will

spot two differences in their names).

It has plenty of peers. China Huayang

Economic and Trade Group claimed to be

one of China’s first soes, but a subsidiary

said in a recent filing that it is in fact a non-

state entity. Huayang has defaulted on 7bn

yuan in bonds. China City Construction

sold 99% of its shares in 2016 to a private in-

vestor, but kept calling itself an soe. It has

since had a string of defaults. Other firms

have embellished their connections. China

Energy Reserve and Chemicals Group Over-

seas Capital Company reassured rating

agencies with its structure, supposedly

traceable to a powerful soe. It defaulted on

a $350m bond last year.

Such stories have become common

enough that Gelonghui, a financial-infor-

mation company, published a tongue-in-

cheek guide on how to become a fake soe.

Find a long-forgotten government institu-

tion; target an official with no hope of pro-

motion; then “be a shameless toady” to get

the institution’s seal to register your com-

pany. Finally, build a maze of subsidiaries.

Fake soes are only a small part of Chi-

na’s economic landscape. But they high-

light two pathologies. First, private firms

struggle to get financing. Banks are more

willing to lend to (real) soes, knowing that

they are less likely to go bust.

The second is poor due diligence. The

belief that the government will prop up

soes is a substitute for assessing their true

value. Chinese investors are not the only

ones who fall prey to this. When China En-

ergy Reserve defaulted, South Korean bro-

kerages made large losses. Barclays, a Brit-

ish bank, was one of its underwriters.

Red flags are often obvious. A recent vis-

it to the registered address of the state firm

listed as the owner of China Nuclear re-

vealed another, apparently unrelated com-

pany. “Ultimately the problem is that in-

vestors aren’t sufficiently rational,” says

Zhang Licong of citic Securities. “They

have their natural biases, and some firms

take full advantage of them.” 7

SHANGHAI

Some firms have lied about their state

pedigree, as investors are learning

Corporate China

Fake it till you

break it

I

t has beena year of mood swings in

financial markets. In the spring and

summer, anxious investors piled into the

safety of government bonds, driving

yields down sharply. Yields have recov-

ered in recent weeks (see chart 1). This is

not the only sign that investor sentiment

has improved.

In general, safe assets have been sold

in favour of cyclical ones. The Australian

dollar, a cyclical currency, is up against

the yen, a haven for the fearful. Some-

thing similar is happening in commodity

markets, where the price of copper, a

barometer of global industry, has risen

against the price of gold (see chart 2).

Equity prices in America have reached

a new peak. But what is more striking is

the performance of cyclical stocks rela-

tive to defensive ones. Within America’s

market the prices of industrial stocks,

which do well in business-cycle up-

swings, have risen relative to the prices

of utility stocks, a safer bet in hard times.

In Europe the stocks of financial firms,

the fortunes of which are tied to the

business cycle, have risen relative to

those of firms that make consumer

staples—food, beverages, household

goods and so on—which are more resil-

ient in bad times (see chart 3).

Investors have also begun to embrace

assets at the riskier end of the spectrum.

A host of emerging-market currencies

have gained against the dollar since the

start of October (see chart 4).

Sentimental journey

The markets

Investors are feeling a bit more chipper

2

3 4

1

Mood swings: four charts that explain the markets

Source: Datastream from Refinitiv

Ten-year government-bond yields, % January 1st 2019=100

May 1st 2019=100, $ terms Currencies against the $

Oct 1st-Nov 12th 2019, % increase

JFMAMJ JASON

2019

70

80

90

100

110

Japanese yen per

Australian dollar

Copper-gold price ratio

JFMAMJ JASON

2019

-1

0

1

2

3

United States

Germany

Japan

MJ J ASON

2019

70

80

90

100

110

S&P 500 industrials

relative to utilities

MSCI pan-Euro financials

relative to consumer staples

01234

Polish zloty

South Korean won

Mexican peso

South African rand

Philippine peso

Chinese yuan

Russian rouble