A SUCCINCT SUMMARY of China’s debt problem is offered by the IMF’s David Lipton. He zeroed in on corporate debt in a speech to the Chinese Economists Society in Shenzhen these few days past:
Overall, total debt is equal to about 225 percent of GDP. Of that, government debt represents about 40 percent of GDP. Meanwhile, households are about 40 percent. Both are not particularly high by international standards. Corporate debt is a different matter: about 145 percent of GDP, which is very high by any measure.
By IMF calculations, state-owned enterprises account for about 55 percent of corporate debt. That is far greater than their 22 percent share of economic output. These corporates are also far less profitable than private enterprises. In a setting of slower economic growth, the combination of declining earnings and rising indebtedness is undermining the ability of companies to pay suppliers or service their debts. Banks are holding more and more nonperforming loans, or NPLs. The past year’s credit boom is just extending the problem. Already many SOEs are essentially on life support.
The Fund’s most recent Global Financial Stability Report estimated that the potential losses for Chinese banks’ corporate loan portfolios could be equal to about 7 percent of GDP. This is a conservative estimate based on certain assumptions about bad-loan recoveries and excluding potential problem exposures in the “shadow banking” sector.
This is potentially a deep fault line running through ‘rebalancing’. Corporate debt problems if left unresolved can quickly become systemic debt problems. Authorities need to move with more despatch than they have done to deal with both zombie companies and the banks carrying their zombie loans — and they can’t deal with one without dealing with the other otherwise they will still be left with insolvent companies or undercapitalised banks.
This will not be easy given the political dimensions involved. The nearest example to draw from might be the experience of South Korea’s chaebol in the aftermath of the 1997-98 Asian financial crisis when those economically dominant and politically well-connected conglomerates had to be restructured. That, though, took both government-supported and court-supervised measures to break the power of the controlling shareholders. China’s legal system might find the latter part a challenge.
Lipton also stresses the importance of reforming the governance inadequacies that created the situation in the first place:
Governance certainly must be based on a robust legal framework: the laws and regulations that establish an effective system of insolvency and enforcement that help create payment discipline. But governance also means regulatory and supervisory policies that promote the proper assessment and pricing of risk at the individual loan level. It means robust accounting, loan classification, loan loss provisioning, and disclosure rules. It means a system that avoids moral hazard.
But there is also a socio-cultural dimension; an acceptance that the transition from a state-directed to a market economy requires the transcension of special interests and connections.