Beijing has bailed out troubled borrowers until now

Chinese authorities, on Friday, allowed the country’s first corporate bond default, inflicting losses on small investors in a painful step toward making its financial system more market-oriented.

Investors in bonds sold in 2012 by Chaori Solar Energy Science & Technology Co., a manufacturer of solar panels, were paid as little as 3 per cent of the interest that was due on Friday, according to two bondholders, one of whom said he put his parents’ savings into the bonds. The company warned earlier this week it had only 4 million yuan ($660,000), and faced an interest payment of 90 million yuan ($15 million).

Until now, Beijing has bailed out troubled borrowers to preserve confidence in its fledgling credit markets. But the ruling Communist Party has pledged to make the economy more productive by allowing market forces a bigger role. The timing of the default was highly symbolic, coming two days after Premier Li Keqiang, in an annual policy speech to China’s legislature, said markets would play a ‘decisive role’ in allocating credit and other resources. The ruling party usually tries to prevent politically sensitive developments during such high-profile events. Its willingness to allow Chaori’s default to go ahead suggested Chinese leaders want to make clear such events are routine.

Financial analysts have expressed concern about rising Chinese corporate debt.Some companies also face pressure due to government efforts to reduce production capacity in industries in which supply exceeds demand, such as steel, cement and aluminium. That glut of supply has depressed prices, sometimes below production cost, causing heavy losses and in some cases forcing companies into bankruptcy. Phone calls to Chaori’s headquarters on Friday were not answered. News reports earlier said many investors in the company’s 1 billion yuan ($160 million) bond issue were retirees and other individual buyers.

Small investors who want a better return than the low interest rates paid by China’s state-owned banks have flocked to corporate bonds and higher-risk investments such as securities backed by packages of credit card and other debt.

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