Audit report reveals China’s economic fault lines

Discovery that state-run firms were inflating their profits shows problems with reform drive, analyst says

PUBLISHED : Sunday, 25 June, 2017, 12:05am
UPDATED : Sunday, 25 June, 2017, 12:05am

Beijing’s push for structural reforms in the economy appears to have sparked a backlash in the form of companies inflating their profitability, according to an analyst.

An official audit report published on Friday said that 18 of the 20 state-owned firms that were audited have in recent years inflated their revenues by more than 200 billion yuan (US$29 billion) and boosted their profits by 20 billion yuan with faked business and manipulated books.

The companies audited include China National Petroleum Corporation, China State Shipbuilding Corporation and Sinochem Group.

Lu Zhengwei, chief economist from Industrial Bank, said that although the fake profits only accounted for a small proportion of total takings at the country’s state-owned entities – less than 2 per cent – it showed the problems they had deleveraging.

“It proves that China’s economy has plenty of difficulties to deal with,” Lu said.

The report also found that China’s local government debt was increasing too fast in some parts of the country, giving an implicit nod to Moody’s decision in May to downgrade China’s sovereign rating for the first time since 1989.

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Beijing aims to cut overcapacity in heavy industry and lower the overall debt burden to keep growth at an average rate of 6.5 per cent until 2020.

However, this year’s audit report paints a bleak picture of how some of the mainland’s largest corporations have gone against the ruling Communist Party’s will over the past year.

In October last year, according to the report, nine of the audited firms were still having trouble cleaning up their 187 “zombie subsidiaries” – heavily indebted entities that were losing money.,

The report also found that China National Building Material, the nation’s largest cement producer, had failed to cut its capacity by six million tonnes as ordered, and had rented 1.39 million tonnes of capacity from other companies to expand production.

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By the end of last year, the report said, three out of the 18 provinces being audited had illegally approved production of 12.59 million tonnes of coal and 1.33 million tonnes of steel.

This flew in the face of official rhetoric about reducing coal and steel capacity by 290 million tonnes and 65 million tonnes respectively in 2016.

When Moody’s downgraded China’s rating by one notch to A1 this May on the basis of insufficient reform to contain debt risks, the central government said the ratings agency overestimated the risks and underestimated Beijing’s ability to keep them under control.

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The report also said that at the end of March this year, the amount of outstanding government debt in the 46 audited mainland provinces, cities and counties had increased by 87 per cent in less than three years.

The last time the National Audit Office mentioned the increase in local government debt in its annual report was in 2012, when it warned of the danger of overly relying on land revenues or taking in new loans to repay old ones.

Besides local government debt, the report also highlighted non-performing loans, bond defaults and shadow banking as key financial risks.