An Active Reaction Is Needed to Corporate Debt, the Gravest Risk to China's Economy
Song Yikang
/SOURCE : Yicai
An Active Reaction Is Needed to Corporate Debt, the Gravest Risk to China's Economy

(Yicai Global) Aug. 30 -- China's GDP growth rate accords with expectations, and indicators like purchase price index (PPI) and consumer price index (CPI) all show that the economic turnaround is gradual but stable.

However, the problem of the corporate debt burden is still a risk of utmost concern in China's economy. How serious then is corporate debt risk in China, and how should we resolve this threat?

On Aug. 28, the ASEAN+3 Macroeconomic Research Office (AMRO) issued a research report titled Chinese Enterprises' Debts: Macro and Industrial Risk Evaluation, and sponsored the seminar on China's debt issues jointly with the School of Economics and Management and the China Institute of Finance and Taxation of Tsinghua University, as well as CBN Research Institute.

Chaipat Poonpatpibul, a senior economist with AMRO outlined the report's main content. Participants then held in-depth discussions during the seminar. They included Chang Junhong, director of AMRO, Xu Heyi, chief economist at AMRO, Bai Chongen, executive vice president of the School of Economics and Management, Tsinghua University, Wen Xinxiang, general secretary of the Monetary Policy Committee of the People's Bank of China, Luo Ping, former director of the training center of China Banking Regulatory Commission and researcher with the National Institution for Finance & Development, Cao Yuanzheng, board chairman of BOC International Research, and Wang Jun the director of the CEIBS-WB Center for Inclusive Finance.

Yang Yanqing, deputy editor-in-chief of Yicai Global and president of CBN Research Institute presided over this seminar.

"Chinese enterprises' debts may be the gravest risk to China's economy, due to both its significance and complexity," noted Bai.

"The rapid increase in enterprise debt is a major challenge facing China's economy, but there will be limits if we analyze risks only per total enterprise debt. To this end, AMRO studied this problem from two perspectives of macro-economy and industries," said Chang.

Debts of Chinese Enterprises Are High, Especially in Some Industries 

By the end of last year, the ratio of corporate debt to GDP in China was 155 percent, per the report, which attributed this debt level to several factors, including the stage of China's specific economic and financial development and some structural and institutional factors. Moreover, China has adopted large-scale economic incentive measures for the economic downtown risks brought about by the global financial crisis, which is another factor compounding corporate debts.

Some industries grow rapidly under the investment-oriented strategy, and corporate debts are also concentrated in those industries including public services, transportation, real estate and architecture, Chaipat Poonpatpibul said. In past years, due to declining profits and insolvency, risks in some industries, including mining, real estate and some state-owned industrial enterprises -- particularly iron and steel enterprises -- have started coming to light. The major source of corporate debts is bank loans, but the proportion of bond market financing and shadow banking financing has increased rapidly in recent years.

The leverage ratio for Chinese manufacturing industry has kept dropping, but made a turnaround continuously in recent years, Xu Heyi said. The service industry is a highlight, and performance of debt/added value is the most outstanding.

Experts in attendance believed that corporate debt problems in China cannot possibly lead to systematic crisis in the short- and mid-term. However, actual and effective measures must be adopted to restrain industrial risks caused by corporate debt and maintain financial stability.

The report offered a 'package program' to resolve corporate debt. Structural reform helps improve investment efficiency, especially for state-owned enterprises. Reform is crucial for successful deleveraging and debt level stabilizing. Market-oriented debt-to-equity swaps also help resolve corporate debt problems. Further, the equity financing market should be further developed and perfected, and enterprises should be encouraged to adopt equity financing rather than debt financing. To maintain financial stability and cope with the impact of debt default, financial institutions, especially those with high loan limits to weak industries, should properly add capital funds and mobility.

AMRO also suggested further consummating corporate debt database to more comprehensively and effectively monitor debt risks.

The Core Problem of High Debt Is Inefficient Resource Allocation

"The AMRO report analyzes the leverage of state-owned enterprises from three perspectives. First, efficiency structure. It studies the input-output efficiency by linking leverage to GDP. Second, industry structure. It uses the three indicators of debt ratio, profit margin and interest coverage to assess the risks of manufacturing, real estate, transportation and service industries. Finally, capital structure. It analyses where the capital is sourced from. This analysis may be helpful for the next-step precise deleveraging," commented Wen Xinxiang, secretary-general of the monetary policy committee of the People's Bank of China.

China's debt ratio is high, especially corporate debt ratio, Cao said. Is there a painless scheme to solve the debt problem? His question triggered a heated discussion among the guests. Most were inclined to adopt a scheme 'without too much pain' to solve China's debt problem.

The steel industry has seen a considerable improvement since last year, Cao believes. The debt ratio has fallen, prices have risen, and debt servicing by banks has improved considerably.

In view of current corporate debt risk, China's financial sector is insufficiently mature, Bai noted, i.e. information disclosure is poor and financial institutions are not very independent. For example, if a bank wants to do business with a local government, it may be difficult for it to decline when the government asks it to continue lending money to a zombie company.

Bai gave a vivid example. If you compare high debt to heart disease, we have enough tools to deal with heart disease (high debt), but while taking medicine to treat heart disease, this can cause other illnesses, such as liver disease (inefficient resource allocation). We need to guard against heart disease and protect the liver. The fundamental way to solve the problem is to really let the market decide the allocation of resources, including the decision of whether to continue to provide financial resources to troubled enterprises.

We cannot ignore the institutional problems in solving the debt problem of Chinese enterprises, said Wang. If institutional problems are unresolved, China's debt problem cannot be alleviated for a long time, rendering difficult the achievement of substantial progress in deleveraging. The core of the debt problem is inefficiency. CNY6 investment produces only CNY1 GDP. This rising incremental capital output ratio (ICOR) is unsustainable.

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Keywords: AMRO , Macro-Economy Risks , Corporate Debt Burden