China Must Quickly Tackle its Corporate Debt Problems

IMF Blog, December 16, 2016

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From 2009 to 2015, credit grew very rapidly by 20 percent on average per year.
The ratio of non-financial private credit to GDP rose from around 150 percent to more than 200 percent.
The ratio increase was about 20-25 percentage points higher than the historical trend.
The resulting “credit gap” is comparable to those in countries that experienced painful deleveraging, such as Spain, Thailand, and Japan.
The corporate credit boom primarily financed infrastructure and real estate, producing overbuilding, a severe overhang of unsold properties (especially in lower-tier cities), and excess capacity in related industries such as steel, cement and coal.
Heavy borrowing combined with falling profits produced excessive debt loads, with the problem worst among state-owned enterprises that benefit from preferential access to financing and implicit government guarantees.

Government stimulus after the global financial crisis relied heavily on lending for infrastructure and real estate.
Implicit guarantees and preferential financing for state-owned enterprises lowered borrowing costs and encouraged excessive leverage.
The macroeconomic outcome included misallocation of credit, overcapacity in key industries, and a buildup of impaired assets in both banks and shadow banks (trust, securities and asset-management companies).

A high-level decision is needed to stop financing weak companies, strengthen corporate governance, mitigate social costs, and accept likely slower growth in the near term.
Such a decision requires buy-in across state-owned enterprises, local governments, and financial supervisors.

Triage: Identify companies in financial difficulty and distinguish between those that should be restructured and those “zombie” companies that have no hope of survival and should be allowed to exit. Because of existing links between state-owned banks and corporations, a new agency could be created to perform this role.
Recognize losses: Require banks to recognize and manage impaired assets. Shadow banks—trust, securities and asset-management companies—should also be forced to recognize losses.
Share the burden: Allocate losses among banks, corporates, investors and, if necessary, the government.
Harden budget constraints: Improve corporate governance—especially on state-owned enterprises—and remove implicit guarantees to prevent further misallocation of credit and losses.

Improve the legal framework for insolvency: Large-scale and expedited restructuring also requires out-of-court mechanisms to complement the existing framework.
Ease the transition: Broaden unemployment insurance coverage, provide income support for displaced workers and help them find new jobs. The social safety net should be improved because closing or restructuring loss-making companies in industries such as coal and steel could result in substantial layoffs.
Facilitate market entry: Dismantle monopolies in services such as telecommunications and health care and foster greater competition.
Improve local government finance: Ensure sufficient taxing powers and revenue sources for local governments to discourage off-balance-sheet borrowing.

If addressed promptly, risks appear manageable.
The IMF authors note it is encouraging that the government has recognized the problem and is taking action.
The comprehensive strategy outlined would allow China to reduce leverage, limit vulnerabilities, and return to a strong and sustainable growth path over the medium term.

Joong Shik Kang, Wojciech S. Maliszewski — December 16, 2016

中国必须迅速解决企业债务问题; 2016年12月16日; IMF博客
- 中国必须迅速解决企业债务问题; 2016年12月16日; IMF博客 (Markdown version)
- 中国必须迅速解决企业债务问题; 2016年12月16日; IMF博客 (PDF)
Resolving China’s Corporate Debt Problem
- Resolving China’s Corporate Debt Problem (Markdown version)
- Resolving China’s Corporate Debt Problem (PDF)