Since taking off five years ago, China’s debt market has had the appearance of a one-way bet. The country’s turbocharged growth meant corporations were typically in good enough financial health to pay back their loans. But even those companies that ran into trouble did not face the risk of default, since the government would order state-owned banks to ride to their rescue. The same principle applied to local authorities, which were put in the position to borrow large sums of money via off-balance sheet financial vehicles.

The era of riskless borrowing came to an abrupt end this month, when the authorities decided to let Chaori, a solar-cell maker, miss an interest payment on a bond, triggering the first default in China’s modern history. It will not be the last. Li Keqiang, premier, has since made it clear that more defaults are “unavoidable” in the Chinese economy. The authorities are now mulling over the fate of Zhejiang Xingrun Real Estate, a provincial developer that is struggling to repay Rmb3.5bn ($569m) of debt.

Beijing’s willingness to allow defaults to happen is welcome. Widespread moral hazard across borrowers and lenders is one of the reasons credit growth in China has spiralled out of control, with total debt rising sharply from 130 per cent to 210 per cent of national income in just five years. Fearing for their money, investors will now be more careful about whom they lend to. Forcing operators to differentiate among companies is a necessary step on the road to interest rate liberalisation. In a market where the government bails out all lossmaking institutions, the cost of credit will not reflect true economic conditions.