ANNUAL REPORT

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SOEs’ Growing Debt Problem
Despite the controlling status enjoyed by some SOEs in China’s
economy—largely due to their monopolistic market positions and
barriers for private sector competitors—inefficiency and mismanagement
of assets run rife. Because SOEs are given access to
cheap financing and lower interest rates * in return for delivering
investments and public services in line with government interests,
they often operate based on state preferences rather than market
principles. 14 As a result, Chinese SOEs face growing corporate
debt, sluggish demand, weak pricing, and high leverage. 15 SOE
profits have been steadily declining in recent years, falling 6.7 percent
year-on-year in 2015 and 8.5 percent year-on-year in the first
half of 2016. 16 To remain viable, many SOEs are reliant on loans
from state banks, leading to the proliferation of ‘‘zombie’’ companies
† that require constant bailouts to operate. Since 2008, nonfinancial
SOEs have increased their loans relative to assets from
53 percent to 64 percent—nearing the United States’ 70 percent
debt-to-asset ratio before the 2008–2009 financial crisis—while private
companies’ loans relative to assets declined over the same period.
17
According to a June 2016 speech by David Lipton, First Deputy
Managing Director of the IMF, ‘‘corporate debt [in China] remains
a serious—and growing—problem that must be addressed immediately
and with a commitment to serious reforms.’’ 18 In the first
quarter of 2016, corporate debt for all Chinese companies rose to
169 percent of GDP (up from 108 percent in 2008), compared to
72 percent in the first quarter of 2016 for the United States. 19
Dr. Lipton’s speech indicates that SOEs account for around 55 percent
of corporate debt. 20 According to Chinese regulators, nonperforming
loans (NPLs) held by Chinese banks amounted to $300
billion, or 2.15 percent of total loans, at the end of May 2016. 21 Although
China’s official NPL ratio is down from 7.5 percent at the
end of 2006, the actual NPL ratio may be much higher. 22 Ultimately,
Dr. Lipton concluded that Chinese SOEs are ‘‘essentially
on life support,’’ warning that if the problem is not dealt with soon
it could evolve into a larger crisis. 23 As a result of surging debt and
stagnant reforms, Standard & Poor’s ratings agency cut the outlook
for China’s credit rating from stable to negative in March 2016, following
similar revisions by Moody’s Investors Service earlier that
month. 24
Efforts to Address Debt
China has begun allowing some state-owned companies to default
to incentivize more prudent investing by SOEs and by other companies
in SOEs. 25 Baoding Tianwei Group, a power generation equip-
* According to an August 2016 IMF report, implicit government financing guarantees grant
SOEs an estimated four to five notch credit rating upgrade (i.e., a B¥ rating under Standard
& Poor’s rating system would be upgraded to a BB or BB+) and lower SOE borrowing costs by
1 to 2 percentage points. International Monetary Fund, ‘‘The People’s Republic of China: 2016
Article IV Consultation: Selected Issues,’’ August 2016, 33.
† A ‘‘zombie’’ company generates only enough revenue to repay the interest on its debt. Because
banks are reluctant to take the losses from a write-down of this debt and apply forbearance,
these indebted firms are given additional time to repay loans. Hugh Pym, ‘‘Zombie Companies
Eating Away at Economic Growth,’’ BBC, November 13, 2012.
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