Plans to liquidate China’s thousands of “zombie” companies are underway in several of its provinces, according to state media, as the government moves towards an aggressive target of eliminating such firms by 2020.
In December, the Chinese government set a goal of closing zombie state-owned enterprises by the end of 2020.
On February 1, it was reported in Economic Information Daily, a newspaper owned by the Xinhua News Agency, that various arms of government, including the regional authorities and the State-owned Assets Supervision and Administration Commission (SASAC – the body that oversees all state assets), are moving forward with liquidation plans in regions including Hebei, Heilongjiang, Henan and Shaanxi.
Closing thousands of such companies – consistently unprofitable firms that remain in operation only because of government subsidies or regular loans from state-owned banks – in less than two years would be an extremely ambitious undertaking in a strong economic environment.
But doing so in the midst of an economic slowdown, exacerbated by the ongoing trade war with the United States, raises questions as to how much the Chinese government can actually accomplish.
China’s economy is growing at its lowest rate for three decades, but analysts have warned that unless it addresses issues of debt and inefficiency, the slump will be prolonged.
Reducing the number of zombie companies could improve the efficiency of the economy in a number of ways.
Closing unprofitable firms in industries with excess production capacity, such as the steel sector, would support prices and profits while easing tensions with trading partners.
It would also allow investment to shift to more productive uses in both the public and private sectors, improving the country’s longer-term growth outlook.
And it would help address the US complaint that Chinese government subsidies distort the domestic market, giving Chinese companies an unfair advantage over international counterparts.
However, the closing of thousands of these companies could dramatically increase unemployment at a time when joblessness is already on the rise.
It is unclear if the services sector would be able to produce enough new jobs to absorb these laid-off industrial workers.
“The disposal of state-owned zombie enterprises is closely related to the core tasks of supply-side structural reform, such as reducing excess capacity and deleveraging” excess debt and risky lending, said Chen Dafei, senior financial analyst at Shanghai-based investment bank Orient Securities.
“The risk associated with [closing] state-owned enterprises is unemployment, but a bigger risk with the move is that it will mistakenly hurt small and medium-sized private enterprises,” Chen warned.
Zombie companies in China’s heavy industries are serviced by networks of smaller firms, supplying everything from equipment to food services to transport.
If the zombie company is closed, many of these small business would go bust, with further consequences for employment, Chen said.
With Beijing prioritising job growth as a means of maintaining social stability, the government could reasonably be expected to take a go-slow approach to closing zombie firms – which would be counter to the ambitious target of closing them by 2020.
In the past, SASAC has merged zombie firms with healthy state-owned companies, in a bid to avoid spikes in unemployment, however, this risks eroding the finances of the healthy firm.
This is not a new problem for China’s authorities: the dangers of zombie firms are well-known. Reform of this part of the economy is at the core of the government’s state-sector structural reform effort.
Until last summer, that effort had been moving forward, led by government campaigns to reduce excess industrial capacity and cut back on pollution.
The start of the trade war and the subsequent slowdown in the economy, however, sidelined those efforts as the government’s focus shifted to stabilising economic growth.
Recently, though, their eradication has re-emerged as a top priority.
A December meeting between 11 top Chinese government bodies – including the National Development and Reform Commission, the powerful planning agency, and the People’s Bank of China, the central bank – resulted in the 2020 pledge, with a list of zombie companies to be closed set to be published within three months.
This message was reinforced from the very top last month.
“[We] must increase our efforts to appropriately handle the problems associated with ‘zombie companies,’” Chinese President Xi Jinping said in a speech on January 22.
“China has reduced its excess steel production capacity by around 150 million tonnes. Some provinces still have a further 20 million tonnes to cut, so we will urge these provinces to accelerate the process,” Miao Wei, the Minister of Industry and Information Technology, said in a press conference on January 29.
In carrying out this mandate, however, government agencies face the challenges of a moving target, both in relation to the number of zombie companies there are, and the amount of debt they hold.
SASAC’s most recent data showed that there were 2,041 central-government run “zombie companies” still operating in early-2016.
Including zombie state-owned enterprises overseen by local governments, the total climbs above 10,000.
However, in a recent report on bankruptcies, Maxime Lemerle, head of sector and insolvency research at trade credit insurer Euler Hermes, suggested that the total number of zombie state-owned enterprises may “exceed 20,000 cases according to some studies”.
A report by China’s Renmin University in 2016, meanwhile, listed the industries with the highest proportion of zombie companies as steel (51.43 per cent), real estate (44.53 per cent) and architecture (31.76 per cent).
Through its deleveraging programme of the last two years, China has made progress on stabilising its huge pile of corporate debt.
Corporate debt as a percentage of gross domestic product (GDP) fell to 155.1 at the end of June 2018, from 157.1 at the end of March.
It was still well above the 93.1 per cent of GDP at the end of 2008, at the very start of the global financial crisis.
But the initiative to close the thousands of zombie companies in such a short period of time threatens to sharply reverse that progress.
“Elimination of zombie companies is a double-edged sword,” said Zhang Yongjun, deputy chief economist at the China Centre for International Economic Exchanges, a Beijing-based think tank.
“On the one hand, it will mean more efficient allocation of investment. On the other hand, a surge in insolvencies in a short period of time will definitely affect economic behaviour and market operations, resulting in an increase in bad debt.”
The International Monetary Fund (IMF), using 2016 data, calculated that zombie companies accounted for 9 per cent of China’s total corporate debt.
However, Nicholas Lardy, senior fellow at the Peterson Institute for International Economics in Washington, said “the IMF probably underestimates the share of zombie firms”.
“Given the decline by two-thirds in the average return on assets of state industrial companies between the pre – global financial crisis period (before 2008) … and the 2016 data presented in the IMF study, it is surprising that the IMF estimate of the share of zombie industrial companies in 2016 (6.5 per cent) was less than half that in the earlier period (15 per cent in 2005–07),” Lardy wrote in his new book, The State Strikes Back, The End of Economic Reform in China.
“Given that a large share of the losses of state firms is generated by firms in the service sector, one would expect that the share of the total debt of all non-financial corporations accounted for by all zombie firms would be substantially higher than the share of debt of industrial firms accounted for by zombie industrial firms.”
The latest data from the Ministry of Finance shows that China’s state-owned enterprises had 115.64 trillion yuan (US$17.14 trillion) in total debt as of the end of December, an increase of 8.1% from a year earlier.