19 November 2018
Many state-owned enterprises are "zombie companies", debt-laden, unprofitable businesses on the verge of death, if not already dead. Photo: internet
Many state-owned enterprises are "zombie companies", debt-laden, unprofitable businesses on the verge of death, if not already dead. Photo: internet

How China could put ‘zombie’ companies to rest

Those who follow China’s ongoing annual “two sessions” conference should be familiar with so-called “zombie” companies, or debt-laden and unprofitable enterprises.

At the National People’s Congress, Premier Li Keqiang and other officials vowed to deal with these inefficient businesses as part of efforts to phase out overcapacity.

It’s obvious that eliminating these zombies is critical to turning around China’s economy.

These companies are dying, many on the brink of bankruptcy and relying on bank loans and government subsidies.

Most of them are state-owned enterprises which benefited from 4 trillion yuan (US$606 billion) in stimulus spending in the wake of the 2008 financial crisis.

As a result, many Chinese firms ramped up their leverage.

Now these companies are grappling with high debt and falling profits amid slumping commodity prices.

Zombie companies have been blamed for runaway borrowing in the private sector which shot up to 205 percent of gross domestic product from 150 percent in 2010, according to the Bank for International Settlements.

That ratio is higher than the 168 percent borrowing in the US during the 2008 subprime debt crisis and close to the peak of 220 percent in Japan.

China’s corporate debt accounts for 166 percent of the GDP which increases the risk of default and saddles the banking system with non-performing loans (NPL).

At present, the NPL ratio is 1.67 percent, widely thought to be grossly underestimated.

Finance Minister Lou Jiwei recently said the NPL ratio might creep up amid as the economy undergoes structural reform.

A Deutsche Bank report put China’s new loans at a record 2.51 trillion yuan in January but warned increased lending might be little help to the economy.

Debt repayment

Five years ago, Chinese companies had money to make new investment after repaying debt.

Now they are struggling to pay back principal and interest from their operating cash flow and any funds from share issues.

The antidote to high-debt companies is deleveraging.

Chinese companies have repaid US$34 billion in foreign currency debt in the third quarter last year, including US$7 billion to Chinese banks.

Cutting costs and restructuring debt is a painful process.

In the US, the government had to bail out financial institutions in order to get rid of bad assets.

At the same time, the Federal Reserve kept pumping money into the financial system and kept interest rates near zero.

Sovereign debt

China’s sovereign debt accounts for 43.5 percent of GDP, behind Japan’s 85 percent in 1990s and 65 percent in the US during the 2008 financial crisis.

There is plenty of room for further monetary easing.

China has reportedly granted six major banks quotas to issue asset-backed securities with non-performing loans as security.

These are Industrial and Commercial Bank of China Ltd. (01398.HK), China Construction Bank Corp. (00939.HK), Agricultural Bank of China Ltd. (01288.HK), Bank of China Ltd. (03988.HK), Bank of Communications Co. (03328.HK) and China Merchants Bank (03968.HK).

Their combined quota is 50 billion yuan.

Ten years ago, Beijing helped remove troubled assets from state-owned banks before they went public in Hong Kong.

It might be time to make a similar move again.

This article appeared in the Hong Kong Economic Journal on March 11.

Translation by Julie Zhu

[Chinese version中文版]

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Department of Investment Analysis at HKEJ

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