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### Introduction: context and risks
- Credit growth averaged around 20 percent per year between 2009 and 2015.
- The nonfinancial private credit-to-GDP ratio, including credit to local government financing vehicles (LGFVs), rose from around 150 percent to over 200 percent between 2009 and 2015.
- The credit ratio at end-2015 was 20‒25 percentage points above the level consistent with the historical trend (a very high “credit gap”).
- Cross-country evidence: out of 43 economies where credit-to-GDP rose by more than 30 percentage points within five years, 38 economies subsequently experienced severe disruptions (financial crises, growth slowdowns, or both).
- Econometric evidence indicates higher probability of a bad outcome when a boom lasts longer than six years, starts at a higher level of financial depth, and develops faster — China meets all these criteria.

### How significant is the problem? (findings and indicators)
- Credit dynamics and financial deepening
  - China’s credit-to-GDP ratio is significantly higher than peers at a similar development level.
  - Sahay and others (2015) found China’s financial deepening excessive relative to advancements in its institutions and regulations.
- Sectoral composition
  - Corporate sector is the main driver of excessive credit creation; credit to households is consistent with peers.
- Corporate financial performance and bank asset quality
  - Leverage rose while profitability fell for listed non-financial companies (2010–2015).
  - Reported NPLs and special mention loans (SMLs) reached about 5½ percent of total loans as of end-2015.
  - Bottom-up estimate: ‘loans potentially at risk’ are estimated at 15½ percent of total commercial bank loans to the corporate sector (defined as loans to borrowers with ICR < 1).
    - Assuming a 60 percent loss ratio suggests potential bank losses on these loans could amount to 7 percent of GDP (IMF, 2016).
  - Top-down estimate from the credit gap: projected loans potentially at risk about 10½ percent of GDP and write-offs 5 percent of GDP.
- Shadow banking and off-balance-sheet risks
  - Shadow products grew by 48 percent in 2015 to reach RMB 40 trillion, equivalent to 58 percent of GDP or 40 percent of banks’ corporate loans.
- Efficiency of credit and investment
  - Credit financed both investment and expansion of corporate balance sheets (cash buffers and longer payables).
  - Credit intensity (new credit per unit of additional GDP) has increased; macro-level credit and investment efficiency declined, resembling pre-crisis patterns in Spain and Thailand.

### Drivers and distortions behind rapid credit growth
- Main flows of funds
  - High and less profitable corporate investment required credit financing after the GFC; household savings financed additional investment via financial intermediation.
  - Credit often exceeded financing needs for investment, leading to corporate balance sheet expansion.
- Stimulus structure and allocation inefficiencies
  - Post-GFC stimulus scaled up infrastructure spending and real estate investment; nonmarket orientation of state or local government-linked corporates led to overbuilding and unsold properties (real estate overhang).
  - Upstream industries (steel, cement, coal) supported by construction boom now face overcapacity and falling capacity utilization.
- Corporate types and incentives
  - SOEs have been more leveraged and less profitable than private firms.
  - Preferential access to financing, land endowments, and implicit government guarantees lead to soft budget constraints, lower borrowing costs (about ½-1 percentage points lower), and an implied credit rating uplift of 2–3 notches for SOEs.
- Sectoral distress
  - High shares of debt with ICR < 1 concentrated in manufacturing, mining, construction, and real estate.
  - Sectors contributing most to debt-at-risk include construction, manufacturing, mining, and real estate.

### Authorities’ plans and recommended comprehensive strategy
- Authorities’ announced measures (highlights)
  - Capacity reduction targets in coal and steel: planned cuts of 10–15 percent of existing capacity over the next 3–5 years.
  - An RMB 100 billion (0.1 percent of GDP) restructuring fund will absorb welfare costs for an expected 1.8 million affected workers.
  - SASAC identified 345 ‘zombie’ firms among central SOEs to be resolved in three years.
  - SOE reform piloted in 2016 with ten programs focusing on mixed-ownership and professional management; plans to remove certain social functions of SOEs.
- Shortcomings of current approach
  - Selective operational restructuring focuses largely on coal and steel, does not cover associated financial losses, and does not extend to other sectors.
  - SOE reform implementation uneven; central SOE reform slow due to complex subsidiary structures.
  - Corporate debt workouts are case-by-case and state intervention is ad-hoc.
- Key elements of the recommended comprehensive strategy
  - High-level coordination across SOEs, local governments, and financial supervisors to stop financing weak firms, strengthen governance, mitigate social costs, and accept likely near-term lower growth.
  - Triage: identify firms in financial difficulty and classify as viable (restructure) or nonviable (liquidate) via market-driven processes or a government-backed entity; use transparent, standardized processes with external expert valuation.
  - Loss recognition and financial restructuring: proactive recognition of impaired losses; use debt-equity conversions, NPL securitization, and sales to AMCs, nested within a strategy addressing root causes.
  - Burden sharing: allocate losses across banks, corporates, and investors; consider moral hazard and social consequences; backstop with government funds if necessary but transparently.
  - Corporate restructuring and governance reform, particularly in SOEs, to prevent recurrence.
  - Hardening budget constraints: remove implicit government guarantees, reform bond market regulation, and change incentives for corporates and banks.
- Implementation sequencing and modalities
  - Intermediate approach: active state role (establish well-staffed, high-level group for policy, decisions, and communication) while allowing market forces to become increasingly decisive.
  - Banks should be incentivized to perform triage, but a separate empowered entity may be needed given state–bank–SOE links.
  - Preconditions: transparency, improved accounting, auditing, appraiser standards, and credit/property registers.

### Supportive measures: legal, social, and market reforms
- Enhancing the legal framework for insolvency
  - Enterprise Bankruptcy Law (2006) broadly aligns with international best practices but is sometimes too concise and difficult to interpret.
  - Insolvency cases are extremely low relative to economy size and have been falling since 2007.
  - Barriers: disincentives for debtors, hurdles for creditors, reluctant courts, solutions outside the law favoring insiders, and weak institutional capacity.
  - Recommended reforms:
    - Further legal clarification (safeguards against insider influence, recognition of quick court confirmation for negotiated reorganization plans).
    - Institutional reforms: strengthen and specialize judiciary, professionalize insolvency administrators, clearer rules and codes of conduct.
    - Develop out-of-court mechanisms that can be confirmed or challenged by courts; assign confirmation cases to a small number of courts to build expertise.
- Easing transition for workers and regions
  - Sectors with high shares of loss-making firms: iron and steel, coal mining, cement, ship building, aluminum, flat glass; construction also at risk.
  - Estimated exit and labor impact:
    - Exit of all loss-making firms in sectors at risk would result in layoff of around 8 million workers (1 percent of aggregate employment): 2.8 million from the six overcapacity sectors and 5 million from construction.
    - Direct output loss associated with firm exits estimated at 1.9 percent of GDP; overall output loss may rise to 2.5 percent of GDP including inter-sector linkages and second-round consumption effects.
    - With firms exiting over three years and re-employment, estimated GDP losses: 0.6 percent in 2016, 0.2 percent in 2017, and close to zero by 2018.
  - Regional concentration of costs: e.g., two-thirds of coal industry layoffs in Shanxi, Shaanxi, and Inner Mongolia; for Shanxi province output loss associated with restructuring could be 33 percent of provincial GDP.
  - Policy support for displaced workers:
    - Improve social safety net: migrant workers without a residency permit numbered 275 million people (roughly 20 percent of the country's population in 2014); coverage rate among urban employees around 45 percent.
    - Labor redeployment funds (LRFs): government announced LRFs for coal and steel sectors but a generic multi-sector LRF design is advised.
    - Fiscal cost considerations: displaced workers experience longer unemployment spells (around 17 months) and subsequent wage losses of about 20 percent; these parameters inform fiscal cost estimates.
- Improving financial discipline and market functioning
  - Regulatory fragmentation across CSRC, NDRC, NAFMII hinders unified enforcement and information disclosure.
  - Credit rating weaknesses:
    - By 2015, over 90 percent of onshore bonds rated AA to AAA by local agencies: AAA 37.50%; AA+ 20.20%; AA 35.10%; AA- 6.40%; A+ 0.44%; A 0.07%; A- 0.03%; BBB and lower 0.26%.
    - Local rating agencies constrained by state intervention; narrow dispersion of ratings obscures issuer risk differentiation.
  - Suggested measures: unified, transparent regulation; strict financial reporting and disclosure; more independent credit risk assessment; phased removal of implicit guarantees (starting with newly issued products) while managing fire-sale risks.

### Managing local government fiscal risks and reforms
- Key figures and observations
  - Off-budget local government borrowing increased substantially since the GFC via LGFVs because local governments were not allowed to borrow explicitly.
  - The ‘augmented’ deficit jumped from an average of around 4 percent of GDP before 2008 to about 10 percent in 2015.
  - Over 40 percent of central government transfers in 2015 were “special transfer payments” conditional on local matching funds.
  - Around RMB 14 trillion of existing LGFV borrowing has been recognized as explicit local government debt, of which RMB 3.2 trillion was swapped into local government bonds as of end-2015.
- Policy measures enacted
  - Bond swap program launched in 2015 under the new budget law to swap existing local government liabilities into local government bonds in 3‒4 years.
  - 2015 budget law allows all provincial governments to issue local government bonds, subject to approval by the National People’s Congress.
  - Borrowing must now be included in the local fiscal budget and elaborated in the context of a medium fiscal plan.
  - New budget law introduces an early warning system and mandatory credit rating for governments issuing bonds.
- Further recommendations
  - Complement the budget law with clear, predictable rules to deal with sub-national insolvency.
  - Revisit intergovernmental fiscal system to ensure sub-national governments have sufficient taxing powers and own revenue sources.
  - Consider a recurrent value-based property tax to reduce moral hazard and common pool problems.
  - Improve markets and public accountability so residents influence service delivery quality.

### Illustrative scenarios for nonfinancial private sector debt (projections and trade-offs)
- Scenarios considered: “Old growth model” and “Proactive” scenario.
- Old growth model (no-reform)
  - Characteristics:
    - Growth remains investment- and credit-heavy and inefficient; soft budget constraints encourage misallocation.
    - Inflation remains low; negative producer price inflation in overcapacity sectors.
    - Credit growth remains high while credit efficiency declines; evergreening of loans more likely than write-offs.
  - Projections:
    - Growth will slow down to close to 5 percent by 2021.
    - Credit-to-GDP ratio will rise to more than 210 percent of GDP by 2021 from about 160 percent in 2015.
    - Elevated probability of a financial crisis and disruptive adjustment; growth can dip to below 3 percent if adjusted by the probability of such a scenario.
- Proactive scenario
  - Characteristics:
    - Comprehensive corporate debt restructuring and efficiency gains; restructuring in overcapacity sectors encouraged.
    - Debt write-offs combined with bank recapitalization allow lending to shift to more profitable sectors.
    - New credit becomes more efficient; credit intensity starts to decline.
  - Short- and medium-term effects:
    - Short-term costs: debt write-offs and corporate restructuring cause labor layoffs and weigh on consumption; investment slowdown drags on growth.
    - Medium-term gains: cleaner bank balance sheets, improved allocation of investment, reallocation of workers to more productive sectors, TFP growth rises after transition.
  - Projections:
    - Growth temporarily dips to 6 percent by 2017 (5½ percent excluding some assumed high-quality fiscal stimulus), but picks up afterwards to 6½ percent in the medium term.
    - Credit/GDP ratio stabilizes short-term and gradually declines in the medium term.
  - Policy needs:
    - Bank recapitalization to avoid disruption in credit supply.
    - Social security provision to laid-off workers to smooth consumption.
    - Combined fiscal costs are considered affordable and generate better debt dynamics than the old growth model.

### Comparative risks and fiscal implications (estimates)
- Debt and risk estimates
  - Potential “debt-at-risk” estimated at about 15½ percent of the total corporate loan portfolio as of end-2015, which could yield estimated potential losses of about 7 percent of GDP.
- Fiscal cost examples and figures
  - Fiscal cost of support for 2.8 million (contextual) is of the order of RMB 300 billion; it rises to RMB 850 billion (1.2 percent of GDP) after including laid-off construction workers.
- Public debt dynamics
  - Old growth model produces worse public debt dynamics because inefficiencies drive GDP growth lower and require fiscal and quasi-fiscal support.
  - Proactive strategy has short-term fiscal costs from recapitalization and worker support but yields stronger medium-term public sector debt stabilization.

### Implementation modalities: pilot program and restructuring tools (appendix summaries)
- Appendix I — Pilot Program to Restructure State-Owned Enterprises (summary steps)
  - Principles: rule of law, market-based approach, safeguard financial stability, avoid moral hazard.
  - Oversight: SOE Restructuring Task Force (Ministry of Finance, PBC, CBRC, CRSC, NDRC and SASAC).
  - Steps include fair-value assessment of claims, sale of loans to an AMC or creditor committee formation, restructuring/resolution via liquidation or rehabilitation plans, transfer of claims/ownership, and use of restructuring fund to assist laid-off workers.
- Appendix II — Modalities of Debt Restructuring (summary)
  - In-court vs. out-of-court: out-of-court workouts recommended where court capacity limited; build enhanced out-of-court mechanisms with structured workout principles.
  - Banks vs. AMCs: bank-led restructuring faces expertise and political pressure constraints; AMCs can expedite disposal but require governance and independence.
  - Financial instruments: debt-equity conversions, NPL securitization, and development of a distressed debt market are discussed with required preconditions.

### Historical context and international lessons (Appendix III and comparative cases)
- China’s 1998–2003 experience
  - Restructuring required more than RMB 2.5 trillion of fiscal resources (near one-third of 1998 GDP).
  - Four AMCs established; transfers involved RMB 1.4 trillion in bad assets at face value.
  - SOE reforms in late 1990s involved large layoffs; SOEs’ share of urban employment fell from 60 percent in 1994 to less than 15 percent in 2015.
- Recent near-default cases (as of May, 2016)
  - Since mid-2014 more than ten defaults or near defaults by SOEs and private bond issuers in the onshore corporate bond market (case summaries provided in source).
  - State intervention was largely ad hoc with no clear guideline defining the state’s role.
  - Market impact muted by faith in bailouts and loose liquidity, though spreads began to widen for overcapacity-sector bonds and some issuances were canceled.
- Lessons from Central and Eastern Europe and Korea
  - Hardening budget constraints, legislative changes, disciplined privatization, and comprehensive corporate governance reforms are critical.
  - Korea combined withdrawal of credit from nonviable firms, large consolidation “Big Deals,” contractual workouts, corporate governance reforms, and social protection measures.

### Projecting growth and credit: methodologies and key quantitative inputs (Appendix IX)
- Scenario macro-outcomes (summary)
  - Proactive reform path: medium-term growth 6½ percent; nonfinancial private sector debt to GDP ratio (excluding LGFV borrowings) stabilizes at 175 percent.
  - Old-growth model: medium-term growth 5.1 percent; nonfinancial private sector debt to GDP ratio rises to more than 210 percent by 2021.
- Credit projection methodologies
  - Credit intensity approach:
    - Definition: new credit per unit of additional GDP.
    - Historical: pre-crisis average 1.1; post-crisis average 2.7.
    - Scenario projections: proactive scenario credit intensity declines to 2.1.
  - Flow of Funds approach:
    - Projects credit flows to finance corporate investment and within-sector flows.
    - Proactive scenario: falling investment ratio and improving corporate profitability reduce external financing needs over time.
    - Old-growth scenario: declining corporate profits require more external financing to maintain high investment ratio; within-sector credit flows continue to rise as share of GDP.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16203.pdf*

### 1. Resolving Zombie Companies across Selected Provinces .....................................................9

### 1. Resolving Zombie Companies across Selected Provinces .....................................................9

### Figures
- 1. Credit Boom and Adjustment: Regional Impact ..................................................................18
- 2. China Deleveraging Scenarios .............................................................................................25

### Appendices
- I. Using a Pilot Program to Restructure State-Owned Enterprises ..........................................26
- II. Modalities of Debt Restructuring ........................................................................................27
- III. China's 1998-2003 Previous Restructuring Experience .....................................................29
- IV. Recent Near-Default Cases ................................................................................................30
- V. Corporate Restructuring in Central and Eastern Europe .....................................................32
- VI. Korea’s Experience with Corporate and Debt Restructuring ............................................33
- VII. Estimating the Impact of Restructuring............................................................................34
- VIII. Managing Local Government Debt—International Experiences....................................35
- IX. Projecting Growth and Credit under Different Scenarios..................................................38

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16203.pdf*

### References .............................................................................................................

### _wp16203 - References .............................................................................................................

### Introduction: context and risks
- China is rebalancing, but high credit growth is a source of concern.
- Credit growth averaged around 20 percent per year between 2009 and 2015.
- The nonfinancial private credit-to-GDP ratio, including credit to local government financing vehicles (LGFVs), rose from around 150 percent to over 200 percent between 2009 and 2015.
- The credit ratio at end-2015 was 20‒25 percentage points above the level consistent with the historical trend (a very high “credit gap”).
- Cross-country evidence: out of 43 economies where credit-to-GDP rose by more than 30 percentage points within five years, 38 economies subsequently experienced severe disruptions (financial crises, growth slowdowns, or both).
- Econometric evidence shows probability of a bad outcome increases if a boom lasts longer than six years, starts at a higher level of financial depth, and develops faster — China meets all these criteria.

### How significant is the problem? (findings and indicators)
- Credit dynamics and financial deepening
  - China’s credit-to-GDP ratio is significantly higher than peers at a similar development level.
  - Sahay and others (2015) found China’s financial deepening excessive relative to advancements in its institutions and regulations.
- Sectoral composition
  - Corporate sector is the main driver of excessive credit creation; credit to households is consistent with peers.
- Corporate financial performance and bank asset quality
  - Leverage rose while profitability fell for listed non-financial companies (2010–2015).
  - Reported NPLs and special mention loans (SMLs) reached about 5½ percent of total loans as of end-2015.
  - Bottom-up estimate: ‘loans potentially at risk’ are estimated at 15½ percent of total commercial bank loans to the corporate sector (defined as loans to borrowers with ICR < 1).
    - Assuming a 60 percent loss ratio suggests potential bank losses on these loans could amount to 7 percent of GDP (IMF, 2016).
  - Top-down estimate from the credit gap: projected loans potentially at risk about 10½ percent of GDP and write-offs 5 percent of GDP.
- Shadow banking and off-balance-sheet risks
  - Shadow products grew by 48 percent in 2015 to reach RMB 40 trillion, equivalent to 58 percent of GDP or 40 percent of banks’ corporate loans (overlap with regular corporate credit hard to estimate).
- Efficiency of credit and investment
  - Increased investment was not matched by commensurate profit increases; credit has financed both investment and expansion of corporate balance sheets (cash buffers and longer payables).
  - Credit intensity (new credit per unit of additional GDP) has increased; macro-level credit and investment efficiency declined, resembling pre-crisis patterns in Spain and Thailand.

### What is behind the rapid credit growth? (drivers and distortions)
- Main flows of funds
  - High and less profitable corporate investment required credit financing after the GFC; household savings financed additional investment via financial intermediation.
  - Credit often exceeded financing needs for investment, leading to corporate balance sheet expansion.
- Stimulus structure and allocation inefficiencies
  - Post-GFC stimulus scaled up infrastructure spending and real estate investment; nonmarket orientation of state or local government-linked corporates led to overbuilding and unsold properties (real estate overhang).
  - Upstream industries (steel, cement, coal) supported by construction boom now face overcapacity and falling capacity utilization.
- Corporate types and incentives
  - SOEs have been more leveraged and less profitable than private firms.
  - Preferential access to financing, land endowments, and implicit government guarantees lead to soft budget constraints, lower borrowing costs (about ½-1 percentage points lower), and an implied credit rating uplift of 2–3 notches for SOEs.
- Sectoral distress
  - High shares of debt with ICR < 1 concentrated in manufacturing, mining, construction, and real estate.
  - Contributed most to debt-at-risk by sector: construction, manufacturing, mining, real estate (sectoral shares and magnitudes reported in source).

### Charting the way out: authorities’ plans and comprehensive strategy
- Authorities’ announced measures (elements of the 13th Five Year Plan)
  - Capacity reduction targets in coal and steel: planned cuts of 10–15 percent of existing capacity over the next 3–5 years.
  - An RMB 100 billion (0.1 percent of GDP) restructuring fund will absorb welfare costs for an expected 1.8 million affected workers.
  - SASAC identified 345 ‘zombie’ firms among central SOEs to be resolved in three years.
  - SOE reform piloted in 2016 with ten programs focusing on mixed-ownership and professional management; plans to remove certain social functions of SOEs.
- Shortcomings of current approach
  - Selective operational restructuring focuses largely on coal and steel, does not cover associated financial losses, and does not extend to other sectors.
  - SOE reform implementation uneven; central SOE reform slow due to complex subsidiary structures.
  - No comprehensive approach to promote financial discipline; corporate debt workouts are case-by-case and state intervention is ad-hoc.
- Key elements of a comprehensive strategy
  - High-level decision: coordinate action across SOEs, local governments, and financial supervisors to stop financing weak firms, strengthen governance, mitigate social costs, and accept likely near-term lower growth.
  - Triage: identify firms in financial difficulty and classify as viable (restructure) or nonviable (liquidate) via market-driven processes or a government-backed entity; use transparent, standardized processes with external expert valuation.
  - Loss recognition and financial restructuring: require proactive recognition of impaired losses; techniques include debt-equity conversions, NPL securitization, and sales to AMCs, nested within a strategy addressing root causes.
  - Burden sharing: plan allocation of losses across banks, corporates, and investors; consider moral hazard, repayment capacity, and social consequences; backstop with government funds if necessary but transparently.
  - Corporate restructuring and governance reform: particularly in SOEs, to prevent recurrence of unsustainable losses.
  - Hardening budget constraints: remove implicit government guarantees, reform bond market regulation, and change incentives for corporates and banks.
- Implementation sequencing and modalities
  - An intermediate approach is recommended: active state role (establish well-staffed, high-level group for policy, decisions, and communication) while allowing market forces to become increasingly decisive.
  - Banks should be incentivized to perform triage, but a separate empowered entity may be needed given state–bank–SOE links.
  - Transparency and improved accounting, auditing, appraiser standards, and credit/property registers are supportive prerequisites.

### Supportive measures (legal, social, and market reforms)
- Enhancing the legal framework for insolvency
  - Enterprise Bankruptcy Law (2006) broadly aligns with international best practices but is sometimes too concise and difficult to interpret.
  - Application of the law is limited: insolvency cases are extremely low relative to economy size and have been falling since 2007.
  - Barriers include disincentives for debtors, hurdles for creditors, reluctant courts, solutions outside the law favoring insiders, and weak institutional capacity.
  - Recommended reforms:
    - Further legal clarification (safeguards against insider influence, recognition of quick court confirmation for negotiated reorganization plans).
    - Institutional reforms: strengthen and specialize judiciary, professionalize insolvency administrators, clearer rules and codes of conduct.
    - Develop out-of-court mechanisms that can be confirmed or challenged by courts; assign confirmation cases to a small number of courts to build expertise.
- Easing the transition for workers and regions
  - Sectors identified with high shares of loss-making firms: iron and steel, coal mining, cement, ship building, aluminum, flat glass; construction also at risk.
  - Estimated exit and labor impact:
    - Exit of all loss-making firms in sectors at risk would result in layoff of around 8 million workers (1 percent of aggregate employment): 2.8 million from the six overcapacity sectors and 5 million from construction.
    - Direct output loss associated with firm exits estimated at 1.9 percent of GDP; overall output loss may rise to 2.5 percent of GDP including inter-sector linkages and second-round consumption effects.
    - With firms exiting over three years and re-employment, estimated GDP losses: 0.6 percent in 2016, 0.2 percent in 2017, and close to zero by 2018.
  - Regional concentration of costs: e.g., two-thirds of coal industry layoffs in Shanxi, Shaanxi, and Inner Mongolia; for Shanxi province output loss associated with restructuring could be 33 percent of provincial GDP.
  - Comparison with past restructuring: 1998–2002 wave had 22 million workers laid off and 50 percent of bank loans written off; policy buffers (e.g., higher FX reserves) are larger now but the economy is growing more slowly.
  - Policy support for displaced workers:
    - Improve existing social safety net: unemployment insurance fragmented and restricted; migrant workers without a residency permit numbered 275 million people (roughly 20 percent of the country's population in 2014); coverage rate among urban employees around 45 percent.
    - Labor redeployment funds (LRFs): can provide transitional income support and rapid redeployment services; government announced LRFs for coal and steel sectors but a generic multi-sector LRF design is advised to ensure equality across sectors and regions.
    - Fiscal cost considerations: displaced workers experience longer unemployment spells (around 17 months) and subsequent wage losses of about 20 percent; these parameters are used to estimate potential fiscal costs of support (detailed estimates in source appendices).
- Improving financial discipline and market functioning
  - Regulatory fragmentation: CSRC approves listed corporate bonds; NDRC approves SOE bonds; NAFMII (managed by PBC) handles interbank market instruments — fragmentation hinders unified enforcement and information disclosure.
  - Credit rating weaknesses:
    - Over 90 percent of onshore bonds are rated AA to AAA by local rating agencies by 2015, an unusually high concentration (AAA 37.50%; AA+ 20.20%; AA 35.10%; AA- 6.40%; A+ 0.44%; A 0.07%; A- 0.03%; BBB and lower 0.26%).
    - Local rating agencies constrained by state intervention; narrow dispersion of ratings obscures differentiation of issuer risk.
  - Suggested measures: unified, transparent regulation; enforcement of strict financial reporting and disclosure; more independent credit risk assessment; phased removal of implicit guarantees (starting with newly issued products) while managing risks of fire sales and panic.

*Italic source: _wp16203 - References (excerpt) from the provided IMF PDF content.*

### 2.8 million, the fiscal cost of support is of the order of RMB 300 billion. It rises to

### _wp16203 - 2.8 million, the fiscal cost of support is of the order of RMB 300 billion. It rises to

### Facilitating Market Entry
- Problem statement:
  - Market entry in the state-dominated services sector is currently more stringent than in OECD economies.
- Recommendations:
  - Make markets more contestable by lowering entry barriers and dismantling monopolies in services (especially telecommunications and healthcare) and utilities (electricity, gas, and water).
  - Allow breaking up administrative monopolies.
  - Promote growth of dynamic small and medium-sized enterprises to foster competition and promote growth.

### Strengthening Fiscal Discipline for Local Governments
- Key observations and figures:
  - A significant part of corporate borrowing in reality financed off-budget fiscal spending.
  - Off-budget local government borrowing increased substantially since the GFC and was undertaken by LGFVs because local governments were not allowed to borrow explicitly.
  - The ‘augmented’ deficit, which LGFV spending gives the fiscal nature of such operations, jumped from an average of around 4 percent of GDP before 2008 to about 10 percent in 2015.
  - A substantial share of central government transfers (over 40 percent in 2015) were “special transfer payments” that provide partial financing conditional on local government matching funds.
  - Around RMB 14 trillion of existing LGFV borrowing has been recognized as explicit local government debt, of which RMB 3.2 trillion was already swapped into local government bonds as of end-2015.
- Policy measures enacted:
  - Bond swap program launched in 2015 under the new budget law to swap existing local government liabilities (mainly LGFV borrowings) into local government bonds in 3‒4 years to reduce interest costs and improve transparency.
  - 2015 budget law allows all provincial governments to issue local government bonds, subject to approval by the National People’s Congress.
  - Borrowing must now be included in the local fiscal budget, which must be elaborated in the context of a medium fiscal plan.
  - New budget law introduces an early warning system and mandatory credit rating for governments issuing bonds.
- Further recommendations:
  - Complement the budget law with clear, predictable rules to deal with sub-national insolvency (Document 43, State Council, October 2014 is a step in the right direction).
  - Revisit the intergovernmental fiscal system to ensure sub-national governments have sufficient taxing powers and own revenue sources to match large spending responsibilities.
  - Consider a recurrent value-based property tax as an ideal tax instrument to reduce moral hazard and common pool problems.
  - Improve markets and public accountability so residents and taxpayers influence the quality of service delivery.

### Illustrative Scenarios for Nonfinancial Private Sector Debt
- Two scenarios considered: “Old growth model” and “Proactive” scenario.

- Old growth model (no-reform) — characteristics and projections:
  - Growth remains investment- and credit-heavy and inefficient; soft budget constraints encourage misallocation.
  - Inflation remains low, reflected in negative producer price inflation, especially in overcapacity sectors.
  - Credit growth remains high while credit efficiency declines; evergreening of loans is more likely than write-offs.
  - Near-term growth remains high supported by quasi-public sector investment and rapid credit growth.
  - Projection: growth will slow down to close to 5 percent by 2021.
  - Projection: credit-to-GDP ratio will rise to more than 210 percent of GDP by 2021 from about 160 percent in 2015.
  - The probability of a financial crisis and disruptive adjustment is elevated; growth can dip to below 3 percent if adjusted by the probability of such a scenario.

- Proactive scenario — characteristics and projections:
  - Assumes comprehensive corporate debt restructuring and efficiency gains; encourages restructuring especially in overcapacity sectors.
  - Debt write-offs combined with bank recapitalization allow banks to redirect lending to more profitable sectors; structural reforms and hardening budget constraints reduce transfers to inefficient sectors.
  - New credit becomes more efficient and credit intensity starts to decline.
  - Short-term costs: debt write-offs and corporate restructuring cause labor layoffs and weigh on consumption; slowdown in investment to bring down credit intensity drags on growth.
  - Medium-term gains: cleaner bank balance sheets, more efficient allocation of investment, reallocation of laid-off workers to more productive sectors, TFP growth rises after transition, boosting potential growth.
  - Projection: growth temporarily dips to 6 percent by 2017 (5½ percent excluding some assumed high-quality fiscal stimulus), but picks up afterwards to 6½ percent in the medium term.
  - Credit/GDP ratio stabilizes in the short term and gradually declines to more sustainable levels in the medium term.
  - A policy cushion is needed: bank recapitalization to avoid disruption in credit supply and social security provision to laid-off workers to smooth consumption.
  - Combined fiscal costs of these policies are still affordable given fiscal space and generate better debt dynamics than the old growth model.

### Comparative risks and fiscal implications
- Debt and risk estimates:
  - Potential “debt-at-risk” is estimated to be about 15½ percent of the total corporate loan portfolio as of end-2015, which could yield estimated potential losses of about 7 percent of GDP.
- Fiscal cost examples mentioned:
  - Unspecified estimates include unemployment benefits, severance pay, transfer payments to partially cover health and migration costs and the fiscal cost of providing labor redeployment services.
  - The fiscal cost of support for 2.8 million (contextual) is of the order of RMB 300 billion; it rises to RMB 850 billion (1.2 percent of GDP) after including laid-off construction workers.
- Public debt dynamics:
  - The old growth model still produces worse public debt dynamics because inefficiencies drive GDP growth lower and attempts to boost it through fiscal and quasi-fiscal support.
  - The proactive strategy has short-term fiscal costs from recapitalization of banks and support to laid-off workers but yields stronger medium-term public sector debt stabilization.

### Conclusion and recommended comprehensive strategy
- Main conclusions:
  - Corporate credit growth in China has been excessive in recent years, linked to large corporate sector investment post-GFC, a credit-financed construction boom, overstocking in real estate, and overcapacity in upstream industries.
  - Investment efficiency has fallen and corporate financial performance has deteriorated, affecting asset quality in financial institutions.
  - Authorities recognize the problem but appear to be still searching for a comprehensive, proactive strategy; current approach is selective and does not fully tackle financial implications.
- Recommended comprehensive, proactive approach elements:
  - Identifying companies in financial difficulties.
  - Proactively recognizing losses in the financial system.
  - Burden sharing.
  - Corporate restructuring and governance reform.
  - Hardening budget constraints.
  - Supporting policies: enhancing the legal and institutional framework, supporting displaced workers, facilitating market entry, and reforming local government finances.
- Trade-off emphasized:
  - The proactive strategy trades short-term economic pain for larger long-term gain: temporary output and employment cuts in overleveraged industries lead over time to higher production and employment as labor reallocates to more productive sectors, producing higher and more sustainable growth with less investment and credit but higher TFP growth.

### Appendix I — Pilot Program to Restructure State-Owned Enterprises (summary steps)
- Principles: rule of law, market-based approach, safeguard financial stability, avoid moral hazard.
- Oversight: SOE Restructuring Task Force (Ministry of Finance, PBC, CBRC, CRSC, NDRC and SASAC).
- Steps:
  - Step 1: Determining fair value of claims held by major creditors of the Target Enterprises; CBRC assesses fair value of loans reflecting losses in banks’ books.
  - Step 2: Two alternatives:
    - (a) Sale of the loans, at fair value, to a newly established asset management company (AMC); or
    - (b) Establishment of a creditor committee by relevant Banks.
    - Preconditions: “safe harbors” for bank officials; appropriate governance framework for the AMC; participation of independent restructuring professionals; principle of value maximization.
  - Step 3: Restructuring/resolution: AMC/Creditor Committee compares going concern vs. liquidation value; select liquidation means for non-viable firms; prepare rehabilitation plans for viable firms including financial (debt reduction, rescheduling, debt/equity conversions) and operational components (business changes, asset sales, management changes, layoffs). Creditors have ultimate decision via vote or court confirmation per insolvency law.
  - Step 4: Transfer of claims/ownership: AMC arranges sale of restructured claims and/or newly acquired equity; under creditor committee approach claims could be retained and equity sold to private investors or SOEs with appropriate governance.
  - Step 5: Utilizing the restructuring fund to assist laid-off workers (transitional income support, targeted labor redeployment services, assistance in self-employment and job creation programs).

### Appendix II — Modalities of Debt Restructuring (summary)
- In-court vs. out-of-court:
  - Out-of-court restructuring is recommended where court capacity is limited; build enhanced out-of-court mechanisms based on structured workout principles, regulatory suasion, master creditor agreements and arbitration clauses, incentives and disincentives to promote participation.
- Banks vs. AMCs:
  - Bank-led restructuring: banks may lack expertise and face political pressures; conditional recapitalization with direct subsidies to restructuring departments has worked in some transition economies.
  - AMCs: can expedite disposal of impaired assets and bring expertise, but governance and independence are critical; politically-motivated loans are hard to dispose of by government agencies subject to pressure.
  - Existing AMCs appear commercially oriented with experience from late 1990s cleanup, but past performance is hard to evaluate due to policy distortions; newly-established regional AMCs could be more susceptible to political pressures.
- Financial instruments:
  - Debt-equity conversion: can address bank and corporate balance sheets; success conditions include strict solvency/viability criteria, proactive bank behavior as equity holders, limits on bank ownership of equity, conversion at fair value with recognition of losses.
  - NPL securitization: can clean banks’ balance sheets but may not directly help corporate restructuring; challenges include lack of depth in domestic institutional investor base, need for supporting legislation and aligned market incentives, and potential transfer of risk outside regulated financial sector.
- Distressed debt market:
  - A more market-based system would facilitate disposal of NPLs, require specialist financial institutions and legal workout agencies, and benefit from better functioning collateral auctions; existing AMCs can help jump-start the market if they have the right incentives and independence.

*Source: IMF staff analysis as presented in the provided content.*

### Appendix III. China's 1998-2003 Previous Restructuring Experience

### Appendix III. China's 1998-2003 Previous Restructuring Experience

### Banking Restructuring and Capitalization
- By 1997, about a quarter of loans at the large state-owned commercial banks were nonperforming, leaving potential losses greater than banks’ net worth.
- Restructuring began in 1998 through capital injections, write-offs, and transfers of bad loans to asset management companies.
- The restructuring spanned for nearly a decade and required more than RMB 2.5 trillion of fiscal resources (equivalent to near one-third of 1998 GDP) (Ma, 2006).
- Four asset management companies (each affiliated with one of the four largest state-owned banks ‘Big Four’) were established to dispose nonperforming loans.
- Transfers involved RMB 1.4 trillion in bad assets (about 20 percent of total loans outstanding balance) at face value.
- Asset management companies had relatively little equity capital and were mostly financed through bonds issued to the four large banks, paying an interest lower than market rates.
- The restructuring appeared costly and did not fully address the moral hazard problem.

### SOE Reforms
- The 14th third-plenary meeting in 1993 set the reform agenda to modernize SOE corporate governance.
- The fifth plenum in 1995 adopted the strategy of “grasp the large, let go the small” to revitalize large SOEs and restructure small SOEs.
- Efforts intensified in 1998 after SOE finances deteriorated markedly; former Premier Zhu Rongji’s reform plan in 1998 accelerated SOE restructuring.
- Measures implemented: financial support, layoffs, buyouts, debt-equity swaps, and corporate insolvency.
- Unprofitable SOEs were rehabilitated; some nonviable ones went bankrupt. Millions of SOE workers were laid off—though subsidies were provided for some (Cao, Qian, and Weingast, 1999).
- Unemployment, by some estimates, rose to double-digit levels.
- Excess workers were absorbed by the private sector, driven by strong growth including from reform dividends and accession to the World Trade Organization in early 2000s.
- State-Administration of State Assets Commission (SASAC) was established in 2003 to manage state assets and exercise ownership rights on behalf of the state.
- Quantitative outcomes:
  - SOEs accounted for 60 percent of urban employment in 1994, about one-third in 2000, and less than 15 percent in 2015.
  - The number of SOEs declined from 262,000 in 1997 to 116,000 a decade later; the number of central SOEs (around 100) was unchanged.
  - The share of total industrial assets of SOEs dropped from 90 percent in 2000 to about 40 percent in 2015.
- Despite costs, the reform set China on a strong and sustained growth path for the next decade; however SOEs continued to take up a sizeable share of credit and total industrial corporate assets.

### Recent Near-Default Cases (as of May, 2016)
- Since mid-2014, there were more than ten defaults or near defaults by SOEs and private bond issuers in the onshore corporate bond market.
- Causes: sharp commodity price drop and severe overcapacity in certain sectors.
- Case summaries:
  - Chaori Co.: private solar energy manufacturer; defaulted on coupon payment of RMB 89.9 million in March 2014; later restructured with payments partly by company and two guarantors including a national AMC.
  - China Shanshui Cement Group: private cement producer; defaulted on bond payment of RMB 2 billion in April 2015; debtor filed for liquidation.
  - Baoding Tianwei Group: subsidiary of a central SOE; missed interest payment of RMB 85.5 million due in April, 2015; six months later filed for restructuring and secured a bailout loan from a state bank; investors started civil litigation.
  - Cloud Live: listed company; defaulted on principal payments in April 2015; short RMB 240.6 million ($39.2 million) needed to pay back RMB 400 million debt; investors filed a lawsuit.
  - Zhuhai Zhongfu: private producer of containers and packaging products; unable to fully repay principal on RMB 590 million corporate bonds maturing in May 2015; China Everbright Bank and the Bank of China limited its freedom to spend its capital.
  - China National Erzhong Group: central SOE; warned investors about possible default in September 2015; parent China National Machinery Industry Corp (Sinomach) acquired all outstanding bonds from investors.
  - Sinosteel Co.: central SOE steelmaker; failed to pay interest due in October 2015 of RMB 2 billion ($315 million); state regulators asked bond holders not to exercise a redemption option and postponed the payment.
  - Dongbei Special Steel Group: local SOE steelmaker; failed to make principal and interest payments totaling around RMB 1.9 billion ($292 million) in March and April, 2016.
  - Shanxi Huayu Energy: unit of a central SOE; defaulted on RMB 638 million ($98 million) due in April, 2016; another 1.5 billion RMB in bond payments due later this year; company said it would pay overdue bonds after receiving capital injection from its parent.
  - China Railway Material: central SOE; requested to suspend trading of its debt instruments amounting to RMB 16.8 billion ($2.6 billion); seeking debt restructuring.
- State intervention:
  - Intervention was largely ad hoc with no clear guideline defining the state’s role in SOEs’ defaults.
  - NDRC’s involvement in Sinosteel seen as strong administrative intervention; Baoding Tianwei case reflected traditional financial support by state-controlled financial institutions.
- Market impact:
  - Unprecedented defaults did not systematically spark market turbulence.
  - Yields on five-year triple-A rated corporate bonds remained close to the lowest level in history; spreads over sovereign yields remained narrow.
  - Faith in government bailouts and loose liquidity conditions contributed to stability.
  - Concerns emerged about rising number of defaults and limited resources to bail out troubled issuers: spreads began to widen for bonds issued by overcapacity sectors and a few planned debt issuances were canceled.

### Corporate Restructuring in Central and Eastern Europe — Lessons
- Hardening the budget constraint was critically important for successful transition to market economies. Key lessons:
  - Address multiple channels for soft subsidies simultaneously: direct subsidies, soft taxation, nonperforming loans, trade arrears between firms, and wage arrears (Toth and Semjen, 1998).
  - Legislative changes to establish financial discipline are important: bankruptcy laws, accounting rules, and financial market regulations.
  - Privatization helps harden budget constraints; empirical studies show privatizing SOEs generally hardens the budget constraint (Pohl and others, 1997).
  - Privatization per se is not sufficient: examples from the Czech Republic, Hungary, and Poland show differing exit rates and budget constraint outcomes.
  - Fragmented ownership does not promote hard budget constraints: Czech voucher privatization resulted in fragmented ownership and preserved close ties with the state (Kornai, 2001).
  - Severing the link with the state is key: Hungary and Poland saw private-sector expansion mainly through new businesses and privatization to investors with fewer state links; insider privatization tends to soften budget constraints (Li, 1998).

### Korea’s Experience with Corporate and Debt Restructuring
- Chaebols’ debt-heavy expansion collapsed ahead of 1997: by end-1997 liability-to-equity ratio for the thirty largest chaebols was 509 percent.
- Korean insolvency system was not capable of rapidly rehabilitating many distressed chaebols; simultaneous distress posed systemic risk.
- Government multi-pronged approach (Mako, 2002):
  - Encouraged banks (by Financial Supervisory Commission; FSC) to announce withdrawal of credit from 55 nonviable companies.
  - Government support for eight “Big Deals” to consolidate businesses in eight sectors suffering from excess capacity.
  - 210 local financial institutions contractually bound to the Corporate Restructuring Agreement (CRA) and embarked on workouts as an alternative to receivership.
  - Initiatives to promote corporate reform: improved financial disclosure and accounting standards; stronger shareholder rights and corporate governance; relaxation of constraints on foreign investment; liberalization of merger and acquisition rules; greater latitude for employee layoffs; improved unemployment insurance benefits; streamlined court-supervised rehabilitation; elimination of domestic cross guarantees; requirements to shed noncore affiliates and reduce leverage; tighter exposure limits on financial institutions; action against anti-competitive intra-chaebol transactions.
  - Building several corporate restructuring vehicles.
- Outcomes and limitations:
  - Total amount of corporate debt remained virtually unchanged even though liability-to-equity ratios decreased (example: manufacturing sector from about 400 percent at end-1907 to about 210 percent at end-1999).
  - Corporations often repaid loans by issuing bonds with higher interest rates and rolled them over (debt-to-debt swap), reducing incentives to restructure.
  - The mechanism helped prompt recovery but also allowed some chaebol (notably Daewoo) to continue expansion financed by bond issues.

### Estimating the Impact of Restructuring
- Methodology: three parts — first-round (direct sector impact), second-round (inter-sector linkages and consumption effects), and phasing-in adjustments including labor reallocation effects.
- First-round effect:
  - Identify share of nonviable firms as number of loss-making firms divided by total number of firms; apply to sector employment and industrial output.
  - Use sector-level capacity utilization as cross-check.
  - For steel sector, output loss assumed less than employment cut due to surplus labor; for other sectors output loss assumed in line with employment cut.
  - Estimates: layoff of 2.8 million in the six overcapacity sectors, and 5 million in the construction sector.
  - Associated output loss: 1.1 percent of GDP for the overcapacity sectors, and 0.8 percent for the construction sector.
- Second-round effect:
  - Six overcapacity sectors are mostly upstream; spillovers expected to be contained.
  - Coefficient of 1.2 applied to first-round effect to capture impact on consumption from laid-off workers (assumes 30 percent of wage cut and 0.6 propensity to consume).
  - For construction sector, apply coefficient of 1.4 due to stronger inter-sector linkages.
  - Estimates suggest output loss including second-round effect may rise to 2.5 percent of GDP.
- Phasing-in the adjustment:
  - Adjustment phased-in over three years, front-loaded.
  - Laid-off workers expected to be gradually absorbed into service sectors.
  - Net output loss reflects speed of labor reallocation and productivity differential between old and new sectors.
  - Results: net impact of overcapacity sector restructuring would be 0.6 percent of GDP loss in the first year, 0.2 percent in the second year, and close to zero in the third year.
  - After adjustment ends, GDP growth will be boosted by 0.2 percent in the fourth year.

### Managing Local Government Debt — International Experiences and Principles
- Principles: ex ante and ex post measures to manage local government debt.
- Ex ante measures:
  - Fiscal targets for aggregates (deficit, debt level, revenue, spending); balanced-budget rules for subnational governments.
  - Trade-offs in setting debt limits: too low limits constrain investment and growth; too high limits risk macroeconomic and financial instability.
  - Direct controls: centralization of borrowing with on-lending, requirements to request permission or justify borrowing from private markets.
  - Procedure-based systems for transparency and accountability: reporting guidelines, publishing fiscal accounts, multi-year budgeting, independent auditing.
  - Some countries require subnational governments to subscribe to a credit rating system to access financial markets.
- Ex post measures:
  - Need for insolvency procedures with: 1) definition of a trigger; 2) provisions for collective debt resolution and negotiation; 3) fiscal adjustment plans to align expenditure with revenue.
  - Insolvency procedures should ensure continued delivery of essential public services and eventual restoration of creditworthiness.
  - Mechanisms must protect creditor rights to reduce borrowing costs and encourage financial market development.

Country experiences:
- Brazil:
  - Despite fiscal targets, experienced three subnational debt crises in the 1980s and 1990s; 1997 federal restructuring of states’ debt equivalent to 11.5 percent of GDP.
  - Restructuring conditioned on states’ fiscal and structural reforms.
  - Fiscal Responsibility Law (adopted in 2000) imposes constraints on spending and budget balances; central government monitors compliance and enforces sanctions.
  - Law sets overall limits on debt level (percent of current revenue net of transfers) and harmonized rules for budget planning and reporting; improved transparency and credibility of hard budget constraints.
- India:
  - Early 2000s fiscal reform program to control growth of current expenditures and reform taxation (move from turnover tax to value-added tax).
  - Central government on-lending to states replaced by market-based financing.
  - Oversight relies on imposed and coordinated fiscal rules and direct controls; constitution prohibits states from borrowing abroad.
  - States with debt-service ratio in excess of 20 percent are classified as having debt stress, triggering central monitoring of additional borrowing.
  - National Fiscal Responsibility Law recommends fiscal deficits below 3 percent of gross state domestic product; most state laws require medium-term fiscal plans with annual budgets.
  - Improvements in disclosure of fiscal risks and reporting of accounting policy changes.
- France:
  - Unitary state with decentralization since 2003; local governments have broad financial autonomy.
  - Management framework includes limit on annual debt service of 50 percent of operating revenue (including interest on guaranteed loans).
  - Direct controls: prohibition on borrowing for non-capital investment; debt payments are compulsory budgeted expenditures.
  - No single borrower may receive a guarantee in excess of 5 percent of operating revenue; total guarantees cannot exceed 50 percent of the debt of the entity receiving the guarantee.
  - Central government retains strong supervisory role; ex post measures include central enforcement of fiscal adjustment and facilitation of debt negotiations.
  - Central government does not provide guarantees for local government borrowing, though small exceptional assistance is available to ensure continued service delivery; local governments can be placed under central control if mandated fiscal targets are not met.

*Source: Appendix III. China's 1998-2003 Previous Restructuring Experience (from the provided PDF content).*

### Appendix IX. Projecting Growth and Credit under Different Scenarios

### Appendix IX. Projecting Growth and Credit under Different Scenarios

### Scenario definitions and macro outcomes
- Proactive reform path
  - Assumes gradual corporate sector deleveraging and full-implementation of structural reforms.
  - Near-term growth: lower (relative to no-reform).
  - Medium-term growth: 6½ percent.
  - Nonfinancial private sector debt to GDP ratio (excluding LGFV borrowings): stabilizes at 175 percent.
- Old-growth model
  - Assumes continued build-up of investment and credit, and no progress on structural reforms.
  - Near-term growth: higher (relative to reform path).
  - Medium-term growth: 5.1 percent.
  - Nonfinancial private sector debt to GDP ratio (excluding LGFV borrowings): rises to more than 210 percent by 2021.

### Credit projection methodologies and quantitative inputs
- Credit intensity approach
  - Definition: amount of credit needed for one additional unit of output (new credit per unit of additional GDP).
  - Historical movements:
    - Pre-crisis average: 1.1.
    - Post-crisis average: 2.7.
    - Example regional pattern: before the Asian financial crisis, China rose from 0.9 to 2.
    - After large-scale debt restructuring, credit intensity fell on average to 1.2 for China and other countries in the region.
  - Scenario-specific projections:
    - Proactive scenario: credit intensity expected to decline to 2.1 (reflecting falling investment ratio and improved efficiency).
    - Old-growth model: credit intensity remains high with continued excess investment and lower efficiency.
- Flow of Funds approach
  - Projects credit flows required to finance:
    - Corporate investment (accounting for investment intensity and profitability of the corporate sector).
    - Flows within the corporate and household sectors (including inter-company lending).
  - Scenario implications:
    - Proactive scenario:
      - Falling investment ratio and improving corporate profitability (reflecting higher productivity growth) cause external financing needs of firms to gradually fall over time.
      - Within-sector credit flow, especially inter-company lending, is expected to stabilize in percent of GDP.
    - No-reform / old-growth scenario:
      - Corporate profits decline further, requiring more external financing to maintain the high investment ratio, artificially boosting short-term growth.
      - Within-sector credit flows (including inter-company lending) continue to rise as a share of GDP.

*Source: _wp16203 - Appendix IX. Projecting Growth and Credit under Different Scenarios.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16203.pdf_