When in 1998 GITIC ran into serious liquidity problems, the central government refused to bail it out. GITIC and many other investment companies around China were wound up and the foreign lenders lost most of their money. But this valuable lesson about debt was lost after the 2008 credit crisis, when the Chinese government was forced to step in to provide huge amounts of liquidity and longer-term financial support to the economy to boost confidence. The budget constraint for Chinese companies, which had tightened after the GITIC default, was loosened once again, allowing innovation and risk-taking as the source of corporate growth to be replaced by almost unlimited access to credit.

Shanghai Chaori's default has been widely commented on as a sign of the fundamental weakness of the country's financial system, and as a warning sign of an inevitable financial crash in China. In fact, it is a sign of health returning to the Chinese financial system, after a long period during which the government seemed to have become stuck in the role of financial underwriter. The inevitable consequence of the government after the 2008 crash playing the role of lender of last resort was that China's corporate and local government debt soared to levels that threatened to become unsustainable.

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Chaori's default will have important consequences for the areas of China's economy that suffer from overcapacity, such as steel and solar panels. The country's financial institutions will examine the prospectuses for new bond issues with the following question uppermost in mind: "Does the borrower have the economic ability to continue generating the positive cash flows that will allow it to make the payments of interest and principal to us, the lenders?" In cases where the answer to this question is "maybe not", and where the local government, itself cash-constrained, refuses to stand as guarantor to the new issuer, companies that need quick cash will be forced to re-examine their underlying business models, or even wind up their activities. Thus the problem of overcapacity that plagues parts of the economy will gradually disappear. If this harder budget constraint for Chinese companies is accompanied by higher interest rates, life could become much tougher for many of them.

The government has been unable to order the closure or limit the activities of State-owned companies that presently dominate large parts of the economy, from heavy and light industry, to telecommunications, retailing and financial services. The government knows, though, that if China is to reach its medium- and long-term goals of increasing living standards for everyone, against a backdrop of a fast-aging population, it has to increase productivity and efficiency in the economy. This is something the army of China's entrepreneurs is standing by to do, given the opportunity.

Thus Shanghai Chaori's default is a key moment in the evolution of China's search for a new model for its economy, one that relies on innovation and efficiency rather than massive investment to generate its sales and profits. The marketization of China's financial sector will promote true economic value as the main arbiter of corporate funding, rather than the self-interest of powerful lobbies or local governments that attempt to reach growth and employment targets while maintaining their own positions. Gradually, uneconomic, low-productivity enterprises will be forced to merge or close. Their roles in the economy will be taken by more efficient players, many of which will not be State-owned, but private.

The author is a visiting professor at Guanghua School of Management, Peking University. The views do not necessarily reflect those of China Daily.