China’s plan to kill zombie firms faces resistance at local level
Fears of mass unemployment and social unrest mean local authorities are reluctant to carry out central government’s plan
Despite a central government drive to cut overcapacity and shut down so-called “zombie” companies, local authorities in China may be reluctant to kill off these loss-making entities, put off by the risk of social instability sparked by large-scale job losses.
China’s powerful economic planner - the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) - recently announced an ambitious plan. It required central government-controlled state-owned enterprises (SOEs) to reduce their excess capacity by 10 per cent in two years and pledged to shut down 345 “zombie companies” in three years.
Trials of the scheme are being conducted first in the steel and coal sectors.
According to the National Academy of Development and Strategy, a government think-tank, zombie companies are defined as those that receive government-backed loans, either directly or indirectly, for two consecutive years.
Five to six million workers may lose their jobs as a result of Beijing’s efforts to reduce overcapacity and shut down zombie companies in crowded sectors, a report by Reuters said earlier this year. By the end of 2015, total employment at SOEs was approximately 62 million, according to government statistics.
The risk of high unemployment and the possible social unrest it causes means local governments have genuine political reasons to keep zombie companies alive, analysts say, particularly as many of these entities effectively prop up the local economy.
“In considerations of political stability and GDP-focused performance evaluation , local governments keep offering ‘blood transfusion’ to zombie companies. For ‘non-zombie companies’, local leaders usually put pressure on them to expand capacity and increase employment and then offer subsidies and cheap loans to maintain the status quo, ” said analysts from China’s National Academy of Development and Strategy in a recent research report.
This policy of providing cheap financing to healthy companies is worsening the problem by creating more zombies and helping them to “stay alive”, the report adds.
As a result of this conflict between central policy and the priorities of local leaders, international market observers are witnessing some confusing policy signals.
By the end of July, China was less than halfway towards its annual target of cutting production capacity in the steel sector, while only 38 per cent of the reduction target in the coal sector had been achieved.
“We think the recent policy direction on reform and corporate deleveraging seems a bit mixed,” said Deutsche Bank analysts in a recent research note.
On the one hand, the central government appears keen to “push forward supply-side reform and to close down weaker companies”, they said. But on the other hand, “we noted several debt restructuring cases of central and local SOEs to help them weather through, such as Sinosteel, Bohai Steel and Shanxi’s seven major coal companies, by lowering interest rates, lengthening loan duration and/or converting debt into equity.”
Tianjin-based Bohai Steel, created in 2010 by the Tianjin government through the merger of four steelmakers, has been struggling to repay 192 billion yuan of debt to more than 100 creditors. Media reports said last week that the giant company may receive a bailout from local government.
It could represent the biggest debt restructuring since the global financial crisis.
State-owned Sinosteel, another troubled steelmaker, has submitted to the State Council a debt restructuring plan to convert half of its more than 100 billion yuan of debt into equity, according to local media reports earlier this month. Sinosteel’s debt-to-asset ratio was 98 per cent during the 2011 to 2013 period.
Bohai Steel and Sino Steel employ a combined 100,000 people.
China has a lot at stake in tackling zombie SOEs. Lessons from Japan suggest the issue could drag the economy into a prolonged period of slowing growth, said HSBC economist Hongbin Qu.
The top leadership realises this and has made cutting overcapacity a policy priority, but the challenge is getting local governments to implement the plan.
“Of course, labour relocation is never easy. More support for laid-off workers, such as training and a better social safety net, is a must,” Qu said.
To motivate local officials, Beijing has made it clear that progress on cutting overcapacity is a key
benchmark for evaluating their performance. In addition, China’s Ministry of Finance has offered 100 billion yuan in additional funding for social security to cushion the short-term impact of the rising number of laid-off workers.
“But more needs to be done, especially considering the large amount of fiscal deposits available,” Qu said. “Meanwhile, more jobs also need to be created to absorb laid-off workers.”
China may want to walk the fine line and adopt a gradual approach to restructuring the zombie companies, but “it is better to act sooner rather than later” before the economy is trapped in a Japan-style prolonged slowdown, Qu said.