China Private Firms Show Way Out of Debt Trap for State Giants

  • Leverage ratios improve at private companies, worsen at SOEs
  • Nation's annual legislative meetings to be held early March

China’s private companies are doing a better job than state-owned peers cutting debt, new research shows, adding to calls for President Xi Jinping to overhaul the country’s industrial sector ahead of annual legislative meetings in Beijing.

QuickTake China’s Debt Bomb

Private companies have cut debt to 53 percent of assets from 58 percent in 2007, while SOEs have seen those figures jump to 62 percent from 55 percent, according to estimates from Shi Kang, an associate economics professor at the Chinese University of Hong Kong who has served as a visiting scholar at the People’s Bank of China. About 40 percent of bank loans to companies go to SOEs, which only contribute to around 10 percent of the nation’s economic output, according to Nomura Holdings Inc.

The central bank plans to boost the amount of reserves that must be locked away by some lenders who increased lending too quickly, people familiar with the matter said Friday, after the nation’s banks extended a record 2.51 trillion yuan ($385 billion) of new loans last month. Xi is balancing attempts to shore up the weakest economic growth in a quarter century with pledges to liberalize financial markets and reduce the role of the state ahead of the National People’s Congress in Beijing, where delegates will sign off on a new five-year development plan.

“The Chinese government must cut implicit guarantees for state-owned companies," said Shi, lead writer of a yet-to-be-published research paper titled "Excess Liquidity and Credit Misallocation: Evidence from China." "With that removed, lenders will no longer treat SOEs favorably. SOEs have to reduce overcapacity and zombie companies must die.”

China will seek to channel more private investment into bloated state firms as it aims to carry out the most sweeping overhaul of the companies that dominate the $10 trillion economy in two decades. The plan aims to reform “zombie enterprises,” while encouraging a “blending” between state and private capital, government agencies overseeing the plan said in statements in September.

Research by Bloomberg Intelligence last year showed that China could have achieved economic growth exceeding 8 percent in the first half of 2015 had the nation’s bloated and inefficient state-owned enterprises kept pace with private firms. Debt at state firms ballooned following government stimulus spending after the global financial crisis.

China’s ratio of overall debt to its economic size will likely climb for at least another four years, according to a Bloomberg News survey, underscoring the risks facing policy makers as they strive to prevent a deeper slowdown without triggering a credit blowout.

Pump Priming

Now, the cooling economy is complicating efforts to rein in obligations. The ruling Communist Party wants to maintain an annual expansion of at least 6.5 percent through 2020, after growth fell to 6.9 percent last year. The nation’s top planning agency is again making more money available to local governments to fund infrastructure projects.

"The higher leverage at SOEs will hurt economic efficiency and long-term growth,” said Zhao Yang, the Hong Kong-based chief China economist at Nomura. “They care less about the long-term risk compared to private businesses because SOE chiefs come and go. Private companies are more cautious in taking out debt and they have started to delever.”

Reform of SOEs is progressing slowly at the local-government level and, based on the current trends, Standard & Poor’s expects more downgrades on those companies over the next 12 months, the rating firm wrote in a Feb. 16 note. Billionaire investor Bill Gross called China’s credit expansion “unsustainable” in a Twitter post Thursday.

“The problem with China is state-owned companies with high leverage are kept alive by the government and the state-owned banks, which has become a huge burden to economic growth,” said Xia Le, chief economist for Asia at Banco Bilbao Vizcaya Argentaria SA in Hong Kong.

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