China’s $18 trillion corporate debt pile is threatening the health of its economy.
The country is riddled with companies with a large debt overhang, some of which continue to be productive, others of which are a drain on resources. China’s top leadership has committed to eliminate the resource-draining “zombie” companies, and allow healthy companies to roll over existing debt for equity shares.However, these measures fall far short of combating the debt problem.
China has been wiping out zombie companies by promoting mergers and bankruptcies among corporations. There’s been progress, albeit slow. In the first quarter of this year, there were 1,028 company bankruptcies, 52.5% more than last year. Domestic-to-domestic merger clearance transactions numbered 28 in 2014 and 66 in 2015.
And the debt-equity swap program is already underway. China Construction Bank has been involved in helping large state-owned enterprises restructure their debt, recently announcing that it will carry out a debt-to-equity swap with Yunnan Tin Group. The latter will swap high interest debt with CCB in exchange for 2.35 billion RMB. Sinosteel was also approved earlier this year to carry out a debt-to-equity swap. China First Heavy Industries will swap debt via a private equity placement by its parent company, China First Heavy Industries Group.
The debt-equity swaps have triumphed over alternatives in internal debates because they are supposed to be market oriented, and losses are to be absorbed by the companies themselves. However, several points can be made about this.
First,arethere functioning market forces in China’s financial sector? Market signals are so muddled in equities, bonds and debt assets due to government guarantees, lack of regulations in some areas and underdevelopment that the nation is constantly riddled by asset price bubbles.
Second, if the government was so interested in forcing companies to absorb losses, it would require them to absorb existing debt, not prolong the debt overhang by rolling it over into equity. The argument is that companies will use the swap to overcome temporary repayment issues, but there is no guarantee that the repayment issues will go away.
After the debt-equity swap is carried out, technically the “debt” morass will be reduced by becoming “equity,” but that is just semantics unless equity holders (banks) gain true ownership in indebted firms. The process is made somewhat more complex by potential fundraising by agencies on the part of banks to fund the swaps by selling bonds to the public.
Banks are encouraged to transfer bad loans to asset management companies (AMCs), which could just transfer the debt sludge into the laps of the government-owned AMCs. This would leave banks as “equity” holders with no real ownership in the firms. Alternatively, banks can securitize bad assets, which may shift the debt to buyers of wealth management products, most of whom are retail customers.
There is no shortage of criticism of China’s debt-equity swap program, but leaders insist this round will be market-oriented. One thing is certain: The debt problem is real; it’s a drag on growth; and policies so far have not gotten rid of it. My gut says this time is no different.
Follow me on Twitter, at @SaraHsuChina.
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