While the attention of the investment world is fixed on Europe’s troubles and unconventional central bank policy, the continuing deterioration in China’s economic data has gone somewhat unnoticed.

Goldman: China Debt Load Unknown, But Could Be Much Higher Than Thought

China’s economic turbulence continues unabated, the country is struggling to reform its state-owned enterprise sector, debt continues to rise, private sector investment is slowing, and it’s becoming harder and harder for the country to meet its economic growth targets.

Corporate defaults are also rising and while it was always expected that this would be the case, Chinese bondholders are reacting in an interesting way to the defaults.

Something interesting is happening in china’s domestic bond market

A research note from Goldman Sachs published earlier this week, highlighted the case of Dongbei Special Steel, a steelmaker with the Liaoning provincial government as the largest shareholder.

Dongbei has officially been in default since March, having missed the principal payment on its RMB 800 million commercial paper and has not since been able to meet the interest nor principal repayments on any of its outstanding bonds. Earlier this week Dongbei announced that it would be unable to make the RMB 64.4 million interest payment on an RMB 870 million private placement note due on July 17.

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Goldman estimates that the steel producer has RMB 7.71 billion of bonds outstanding, all of which are now assumed to be in default. The bank has tracked 18 significant defaults for Chinese corporates since 2014, seven of which have fully repaid the outstanding debts due. The remaining eleven issuers have defaulted on debts amounting to 0.23% of China’s total domestic corporate bond market and the end of 2015.

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What’s interesting about the Dongbei default is the fact that at a recent bondholder meeting, bondholders requested that the China Securities Regulatory Commission, China Banking Regulatory Commission and National Development and Reform Commission halt fundraising by the Liaoning provincial government and the enterprises in Liaoning province due to the province’s role in the bankruptcy. As Goldman explains:

“According to local news (Caixin), a bondholders meeting took place earlier this week, with bondholders requesting that the CSRC, CBRC and NDRC halt fundraising by the Liaoning provincial government and the enterprises in Liaoning province, and that institutional investors should stop purchasing bonds issued by the Liaoning government and the enterprises in Liaoning province. According to news reports, this demand stems from disappointment in progress by the provincial government in resolving Dongbei Special Steel’s debt problems, with a lack of information and no clear resolution plan.”

These demands are the first signs that investors are already starting to become fed up with Chinese policymakers handling of the country’s debt crisis. There are already some indications that the events surrounding Dongbei Special Steel will have a significant further impact on China’s domestic corporate bond market.

Domestic bond issuance started to slow in May and investors are rapidly adjusting to higher default risk. As shown in the chart below, corporate bond spreads on sectors such as mining and steel have blown out rapidly since the beginning of the year.

Something interesting is happening in china's domestic bond market
Something interesting is happening in china’s domestic bond market