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Why China hasn’t seen more defaults

Despite starting the year with dire predictions that China faced a slew of defaults, few mainland borrowers have welshed on their debts, thanks to various stripes of government intervention.

"The central government earlier this year issued a decree saying [local governments] need to focus on preventing financial or regional systemic risk," Donna Kwok, senior China economist at UBS, told CNBC. "Local governments have taken this to heart," stepping up intervention either by directly or indirectly bailing companies out or actively mediating between corporates and banks, Kwok said.

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China's debt levels – which soared to 250 percent of gross domestic product (GDP) according to some estimates – have been a major concern for investors for years, spurring fears that the surge in borrowing is fueling a dangerous property bubble and overcapacity in many industries, including steel, mining and solar energy, any of which could face collapse as the economy slows and Beijing tries to choke off overinvestment.

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Concerns spiked anew after little known Huatong Road & Bridge Group Co. warned last week it wouldn't be able to pay down its debt, likely marking the first time a Chinese company is set to openly default on both principal and interest for a bond.

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Reuters reported late Wednesday that sources directly involved said Huatong Road's aggressive fund raising, combined with funds contributed by local government bodies in Shanxi province may have enabled the company to avoid a default.

In addition to managing the bond market, the government is also looking to keep the shadow banking sector, which accounts for around a quarter to a third of total credit, on an even keel, Kwok noted.

"They've been trying for the last few months to re-intermediate some of the credit away from the shadow banking system back to formal bank loans, which arguably is in a much more solid and firmer state," she said.

Others cite the mainland's recent easing of credit conditions are helping to support the bond market, but risks still remain.

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"The outlook over the coming months is unusually uncertain" for credit policy, especially amid signs that Chinese bond issuers are becoming more sensitive to credit access, Morgan Stanley said a note last week on China's bond market.

"Compared to their global peers, Chinese corporates are more leveraged, more short-term funded and typically generate negative free cash flow," it noted. The bulk of debt for many Chinese high-yield issuers, which are riskier by definition, is still made up of short-term bank loans, it said.

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In addition, easing credit isn't floating all borrowers' boats, it noted.

"Even as credit conditions improve, they still appear to be benefitting larger, higher-rated credits far more than smaller, lower-rated peers," Morgan Stanley said. "China is increasingly a two-tier credit market."

Banks, which directly or indirectly fund more than 80 percent of China's total credit, have been exercising pricing power, with 70 percent of the loans in the first quarter extended at above-benchmark rates and as much as 25 percent priced above 8.5 percent yield, it noted.

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To be sure, UBS's Kwok also noted that just because things have been relatively quiet on the default front doesn't mean the risk has gone away.

Others expect more defaults ahead.

"More credit risk events are looming in China's overleveraged economy, and some may be related to the ongoing property correction," Nomura said in a note last week.

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House prices on the mainland increased at double-digit rates throughout most of 2013, but began cooling toward year-end as government tightening measures started to take effect.

"The property market correction reduces developers' demand for land, but also strains the fiscal finances of the heavily indebted local governments that rely on land sales to finance their budgets," Nomura said. "That said, the situation is delicate, and the balance of risks is skewed to the downside," Nomura said.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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