Why China keeps bailing out ailing heavy industries
Debt dilemma reflects conflicting desires for prosperity that comes from free-market competition while ensuring state companies still dominate the economy
Drowning in debt, metals trader Sinosteel Corp got an unprecedented lifeline last month from the Chinese government - a multibillion-dollar debt-for-equity rescue that could be the first of many for struggling state-owned companies.
China’s economy is still growing relatively quickly, but a prolonged slowdown is raising fears that companies in many industries have borrowed and invested too much, too fast, posing a serious risk for the world’s second-largest economy.
The government hailed the Sinosteel deal, in which state-owned banks agreed to accept shares in the company to repay half the 60 billion yuan (HK$68 billion) it owes, as a model for debt reduction. Analysts are more sceptical. They say such manoeuvres are typical of the ruling Communist Party’s tendency to avoid bold action and support politically favoured state industry.
“They are still tinkering at the edge of the problem instead of tackling it head on,” said Mark Williams, chief Asia economist at Capital Economics.
Total debt owed by companies and households in China is estimated by private sector analysts to amount to 250 percent of annual economic output, high for a developing country and close to the levels of the United States and the European Union before the 2008 crisis.
Debt has risen at double-digit annual rates since the crisis as Beijing repeatedly used infusions of credit to shore up economic growth and avoid politically risky job losses.
Lending grew by 17 to 18 per cent last year, outpacing the rise in savings by China’s famously thrifty households, according to Standard & Poor’s. It said that leaves banks with slimmer “funding buffers”.
Explosive economic growth that peaked at 14.2 per cent in 2007 helped China power its way out of previous financial quandaries. That is no longer assured now that growth has tumbled to less than half that level at 6.7 percent for the first nine months of last year, the weakest since 1990.
The bank regulator reported in October that loans on which borrowers have made no payments in 90 days had passed two trillion yuan.
That is equivalent to a relatively modest 2.15 per cent of total lending, but private sector analysts say the true level is far higher at up to 19 percent, or nearly 18 trillion yuan. They say banks fail to include loans to state companies in their count because they assume the government will bail them out.
A banking crisis like those that hit Japan and South Korea in the 1990s is unlikely because both Chinese lenders and major borrowers are state-owned, so as a last resort, the government could order creditors to keep lending and then replenish their balance sheets, economists say.
That would keep banks solvent, but might divert money from investment in productive companies or from paying for schools, health care and other public services needed in China’s rapidly aging society.
“You can get away without a crisis over the next few years, but you won’t be able to avoid slower growth,” Williams said.
The latest plan for Sinosteel calls for transforming some of its debt into “convertible bonds” that creditors can redeem later for stock, according to Bank of China, which led a consortium of lenders. It said regulators would press the company for “internal reform”.
The business magazine Caixin reported that half of Sinosteel’s debt would be turned into such bonds.
Lenders that accept Sinosteel stock still can lose money if its finances fail to improve, said Sheng Hong, director of the Unirule Institute in Beijing, an independent economic research group.
“Banks should have refused the deal right from the start,” he said.
The debt dilemma reflects the leadership’s conflicting desires for the prosperity that comes from free-market competition and for ensuring state companies will still dominate the economy.
Under President Xi Jinping, the Communist Party has pledged to clear up debt and get banks to finance productive activity instead of subsidising state companies. But the debt burden has kept rising as Beijing avoided taking painful, decisive action.
Regulators say they will use market forces to force state companies that control industries including steel, utilities, telecoms, airlines, banking and insurance to become more efficient. But they have ruled out allowing any to go bankrupt. The ruling party’s latest economic blueprint for 2017 promises “financial stability,” which suggests Chinese leaders might be leery of pushing companies so hard they might collapse.
Bailing out companies such as Sinosteel that are deemed strategically important could set back efforts to shrink bloated heavy industries.
A glut of production in steel, aluminium and other industries where supply exceeds demand has led to price-cutting wars and complaints that low-cost Chinese exports are threatening jobs in the United States and Europe.
Instead of state-engineered bailouts, the companies could just sell off equity stakes and use the proceeds to pay debts, Citigroup economists Li-Gang Liu and Xiaowen Jin said in a report.
Sinosteel has operations in mining, steel trading and engineering. It came close to defaulting on a two billion yuan bond payment in 2015 before regulators intervened and persuaded creditors to wait.
Bank of China described the Sinosteel debt-for-equity deal as a model for future debt restructuring.
But some companies that get such relief might “lose motivation to improve”, said Zhang Yingjie, research director for China Chengxin International Credit Rating. “The key lies in how to select the enterprises.”
Williams at Capital Economics said: “They are selling this as dealing with the debt problem and creating viable businesses, but it seems to me it is aimed at making sure state-owned firms can continue to dominate.”