25 October 2016
The cement industry in mainland China is one of those plagued by overcapacity. Photo: internet
The cement industry in mainland China is one of those plagued by overcapacity. Photo: internet

China has to clean up ‘zombie firms’

Axing China’s large number of “zombie firms”, which are debt-laden and unprofitable, is a top priority of the country’s policymakers.

These companies have managed to survive so far with government loans and support.

Unlike firms that have got into trouble because of their operations, zombie firms solely depend on external support.

However, it’s quite a tricky issue, as many social issues will arise if the government decides to let these zombie companies collapse.

In fact, these zombie firms have created jobs and helped to stabilize the markets.

Without these companies, a lack of jobs might already have threatened social stability.

Nevertheless, does that mean China should tolerate such a large number of zombie firms?

Is it worthwhile for the government to continue to support these debt-laden companies?

Zombie firms have taken up a lot of resources that could have been deployed to emerging companies.

And these firms are able to cut their prices sharply to boost sales, which has hampered competitors that must play by market rules.

In this way, zombie companies are detrimental to long-term economic growth.

China will unveil detailed plans to deal with zombie firms this year and help them exit the market properly, an official of the Ministry of Industry and Information Technology said.

The central government is determined to phase out excess capacity and get rid of these zombie companies, which have wasted so much in resources, bank loans and market room.

This is the first year of China’s 13th Five-Year Plan period.

Beijing has placed capacity elimination and inventory clearance high on its agenda.

Eliminating excess capacity and zombie firms are the two major tasks.

Many coal and steel companies are grappling with huge losses owing either to microeconomic issues or the macroeconomic slowdown.

It’s very hard to determine which firms are good and which are bad.

In fact, zombie companies usually exist in sectors that have severe overcapacity.

The steel, coal, plate glass, cement, electrolytic aluminum, shipbuilding, petrochemical, photovoltaic and wind power sectors are the nine industries with the worst excess capacity.

There are 266 zombie firms listed on the stock exchanges, the mainland media says.

Of these, 197 are traditional manufacturers, mainly from the steel, non-ferrous, paper making, textile, shipbuilding, petrochemical, chemical, machinery, cement and coal sectors.

There are 18 companies in the wholesale and retail industry, 10 property developers and five construction firms.

In early December, the producer price index in these sectors with overcapacity problems had declined for more than 40 months.

These industries contributed 70-80 percent of the overall decline in PPI.

How to encourage these zombie firms to exit?

Overcapacity needs supply-side reforms.

It’s not easy to determine whether an industry has excessive capacity.

For example, China needs to import good coal despite the excessive domestic supply of coal.

Also, the authorities have to streamline the internal operations and management of these state-owned companies to push ahead the reforms.

On one hand, the government should adopt measures to let these zombie firms exit in an orderly manner, so as to ease overcapacity.

On the other hand, the government should provide support for laid-off workers in providing retraining and encouraging them to start their own small businesses.

The central government has said it will clean up all zombie companies that have suffered losses for over three consecutive years and will strive to reduce losses substantially by the end of next year.

So, Beijing can be expected to step up its efforts to crack down on these zombie firms.

This article appeared in the Hong Kong Economic Journal on Feb. 22.

Translation by Julie Zhu

[Chinese version中文版]

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Senior investment banker

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