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Amid Ukraine and Gaza, China default raises fears

A little-known Chinese firm at risk of a landmark bond default has set alarm bells ringing among investors in the world's second largest economy.

Against a backdrop of geopolitical tensions in Ukraine and Gaza, Huatong Road & Bridge Group Company warned this week that it would not be able pay down its debt, potentially making it the second default in the onshore bond market this year after a Shanghai energy firm failed to make an 89 million yuan ($14.5 million) interest payment in early March.

Huatong's predicament is set to mark the first time a Chinese company has openly defaulted on the principal and the interest for a bond. The principal of a bond is how much an investor originally borrows, the interest is the extra money that investors have to pay back to the lender. It would also be the first default on China's interbank bond market - the country's largest bond market - which holds 94 percent of bond issues, according to Reuters.

Read MoreChina firm warns of interbank bond default

Ryan Huang, a market strategist based in Singapore for brokerage IG Markets, said that traders were likely to remain jittery on Friday, with news of this potential default adding to global concerns. He added that it showed more "signs of stress" on the corporate debt front in the country.

Joao Monteiro, an analyst at Valutrades, said that the default threat was the biggest concern for investors in Shanghai this week, although the index erased early losses in Friday's session to end 0.2 percent higher, snapping a two-day losing streak.

"This would be another sign that we're moving into bubble territory and investors would be perfectly justified to be showing signs of concern," he said in a research note.

Construction workers started their work early in the morning in Rizhao, Shandong, China.
TPG | Getty Images
Construction workers started their work early in the morning in Rizhao, Shandong, China.

China's debt problems have been a major concern for investors in recent years. It has led to fears that a rise in borrowing is fueling a dangerous property bubble despite the government trying to impose financial reform. In most free market countries, a bond default of this size would be relatively insignificant, but in Communist China - where an event like this is rare - more investors are likely to take notice. March's default was, for many analysts, a clear message from the government to lenders and borrowers that the days of easy credit were over.

Read MoreChina property stocks jump on hopes curbs will be relaxed

State media reported on Friday that the company is getting support from its local government to hold off creditors and raise capital, according to Reuters. Huatong has previously stated that the missed payments have stemmed from an official investigation into its CEO regarding alleged criminal wrongdoing. The bond is a one-year short-term bill that is due to mature on July 23.

China growth hit?

Unlisted Huatong is located in Shanxi Province and is focused on road and bridge construction, real estate development and coal mining. Analysts at Nomura, quoting local media reports, said that the business has connections with the government. Hong Kong-based analysts at the investment bank also highlighted two other potential defaults looming in the country, with Jiangsu Hengshunda Bio-energy and an investment vehicle for Hansen Hengfa Investment both being in arrears of payment.

"It appears more credit risk events are looming in China's overleveraged economy, and some may be related to the ongoing property correction," the team of analysts, led by Chang Chun Hua, said in a note on Thursday. "We reiterate our view that there will likely be more individual credit risk events this year."

Read MoreChina property stocks jump on hopes curbs will be relaxed

These events will likely push up risk premiums in China, they said, thus raising financing costs which could mean the government will loosen policy further to manage these credit risk events and maintain its growth targets.

"The situation is delicate, and the balance of risks is skewed to the downside. We forecast 7.5 percent GDP (gross domestic product) growth this year, but 6.8 percent next year," Nomura said.

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