The dusty streets of Shandong’s Zouping county present a picture of a roaring Chinese economy, with yellow-helmeted construction workers moving in groups, tankers with liquefied aluminium shuttling between factory gates and coal trucks forming long queues on roadsides. Zouping, population 800,000, is one of China’s richest counties. It’s home to the country’s biggest privately-owned aluminium smelter, a big corn oil and steel conglomerate, and hundreds of other industrial enterprises. But the picture of prosperity is starting to fade at the heart of the polluted county town, the location of the office tower of Qixing Group, whose name literally means Star of Shandong. The building became the epicentre of a regional debt crisis in recent weeks. The crisis, brought under control after the local authorities stepped in, wiped billions of yuan from the valuations of the nine listed companies based in Zouping and raised fresh doubts about the true dangers of the mountains of debt underpinning China’s economy. “Corporate sector debt has now risen to quite a high level because of China’s investment-driven growth model,” said Shen Jianguang, chief economist at Mizuho Securities Asia in Hong Kong. State-owned enterprises and large private businesses that could affect local economies and employment were particularly indebted, Shen said, and Beijing’s attempts to cut corporate debt levels had fallen short of the mark. China banks reduce loans in March, amid fears over debt build-up China’s accumulation of corporate debt since the global financial crisis of 2007-08 has been one of the most spectacular debt booms in economic history. It had swollen to 166.2 per cent of national gross domestic product by the end of September, up from 96.3 per cent in 2008, according to the Bank for International Settlements. The level in the United States is 72.8 per cent and the average for emerging markets is 105.9 per cent. The country has been trying many ways, including bank credit rollovers, debt-to-equity swaps and the repackaging of debts, to prevent defaults. President Xi Jinping made “reducing leverage” in the economy a priority shortly after he took power but has failed to stem the tide, with China’s total credit, including formal bank loans and murky shadow banking credit, showing no sign of shrinking. And debt was still a major factor underpinning mainland China’s 6.9 per cent GDP growth in the first quarter of this year, which exceeded the government’s 2017 target of 6.5 per cent. Zouping is one place that rode to prosperity on that wave of debt. Taking advantage of easy credit when China unleashed a massive stimulus package to bolster growth after the global financial crisis, Zouping tripled its aluminium production capacity in just a few years, becoming China’s biggest production base. How the debt bubble burst for China’s Huishan Dairy As one of the biggest industrial players in Zouping, Qixing was showered with credit to expand its aluminium capacity and downstream extrusion factory thanks to its close ties to local governments and banks. In addition to its core aluminium business, Qixing ventured into property development, power cables and ceramics and even a five-star hotel. But those business forays turned sour as China’s economic growth slowed. The conglomerate, which once had 12,000 employees, ran out of cash at the end of March after borrowing more than 7 billion yuan (US$1 billion) from 36 financial institutions and an unconfirmed amount – which China Business News put at about 4 billion yuan – from private lenders. On a recent visit to Zouping there was no sign of production at Qixing’s flagship plant. A few workers could be seen strolling behind the aluminium smelter’s steel-bar fence but only a few trucks emerged from the downstream extrusion profile factory. About 20 electric bikes were parked at the gate of the compounded, where three uniformed security guards denied entrance to non-employees. They also tried to stop workers from talking to the South China Morning Post. A young worker buying lunch from a vendor outside the compound said Qixing’s lithium manganate workshop was still operating and the talk among workers was that the group was under “trusteeship”. Debt distress in Shandong province illustrates risks of interlocked credit guarantees When Qixing’s debt problem was made public in late March, it triggered a chain reaction in Zouping, where private enterprises were used to providing credit guarantees to each other. According to one public document published by the Shanghai Clearing House, Xiwang Group, a company based about 10km from Qixing, had provided 2.5 billion yuan in credit guarantees to Qixing by the end of June last year. Shares of Hong Kong-listed Xiwang Special Steel dropped as much as 14.8 per cent in trading on March 31 as international short sellers saw the risks before eventually closing down 6.5 per cent at HK$1.01 (12.99 US cents). Xiwang’s credit guarantee to Qixing, in the form of a mutual guarantee, is a common practice by Chinese companies seeking to secure credit. But analysts warn it can easily amplify risks and cause crises if a weak link is broken. “The precondition for a mutual guarantee is that [the firms] must have no business overlaps or connections. Otherwise, it may actually amplify risks,” said Lu Zhengwei, the chief economist at Industrial Bank in Shanghai. The mutual guarantee network previously unravelled in two large credit risk incidents in China: a financial crisis in Wenzhou in 2012 and a steel-trade credit meltdown in the Yangtze River Delta in 2014. Rising bad debts in China a boon for some investors Zouping’s county government wasted no time in coming to Qixing’s rescue. It held a meeting with creditor banks on March 27, asking them not to recall bank loans to Qixing, and instructed Xiwang, Zouping’s second-largest business, to help repay interest for Qixing. A three-party agreement reached on April 3 between Xiwang, Qixing and the county government saw Xiwang take over the management of Qixing Group, the official Xinhua news agency reported. The provincial government called another meeting two days later at which Wang Shujian, a Shandong vice-governor, asked the province’s finance office, the banking regulator and local governments to support Xiwang’s management of Qixing. Big bank creditors also pledged continued support, the China Securities Journal reported. However, Qixing’s owners, unhappy about losing control of their conglomerate overnight, resisted the local government’s plan to ask Xiwang to take over its management. Qixing vice-president Zhao Qiang, the son of the company’s chairman, was detained by Zouping police for opposing the takeover plan, according to local media reports. Employees at Qixing’s general office and planning department declined to comment. Calls to Xiwang Group went unanswered. Collaboration between a big borrower, a number of creditor banks and a local government to roll over credit or even to bail out a troubled borrower has become a common practice in China, where 12,836 creditor committees had been set up by the end of last year, involving combined debts of 14.85 trillion yuan. Dozens of legal experts held a symposium in Beijing on April 14 to discuss whether it was appropriate for local governments to step so deeply into companies’ debt problems. China must urgently tackle soaring corporate debts, says OECD But the Zouping county government’s rescue of Qixing might be “necessary to prevent the spread of risks”, said Zhou Hao, the Singapore-based chief emerging markets economist at Commerzbank. “It is about China’s bottom line of preventing regional financial risks.” Zouping residents say Xiwang is too big to fail, and that should keep Qixing afloat. “Everything should turn better after the trusteeship,” said an old man who used to work for Fangong Liquor Brewery, now a subsidiary of Xiwang. “Qixing still has some good assets and it is only a cash flow problem.” He pointed at the nearby buildings and said half of Zouping’s homes relied on Qixing for heating and power supply, and that meant it could not be allowed to collapse even if it was unable to repay its debts.