If the people in India and abroad boycott Chinese products, the debt cuts would not save the Chinese economy from a ceaseless spate of corporate failures and a consequent full blown banking and monetary crisis
Bhagwati Prakash Sharma
The recent adventurous attempt of the Chinese government to bail out its vast and ailing corporate sector, reeling under an unsustainable pile of $18 trillion is beyond common imagination. The proposed measures inter alia include swapping of debt with equity, which may bail out the
companies. But, it can bring down the entire banking sector of China. However, nothing less than such an unprecedented financial adventure or misadventure can save this second largest economy of the world, at a time when the corporate China is sitting on a pile of $18 trillion in debt, equivalent to about 170 per cent of its GDP, when the global demand is sagging and 60 per cent of its output is based upon export led demand. Majority of its companies can hardly survive under such a heavy debt servicing liability, when their capacities are highly under-utilised due to global recession.
This huge pile of corporate debt, otherwise can trigger a ceaseless spate of corporate closures, which might erode and destablise the entire Chinese economy if the corporate sector is not given this. So proposed, debt relief. The loss to the economy in monetary terms then would be much more than that being incurred in the proposed debt restructuring, and the consequent
corporate closures, on account of huge debt, could wipe out its (Chinese) vast production capacities and erode most of its exports, and wipe out its trade surplus and forex reserves to invite a doomsday. To avert any such fateful spate of economic mishaps alone, China has unveiled these debt structuring guidelines, issued on October 10, to trim the rising corporate debt levels. Though, several analysts still fear that it would also destabilise the Chinese economy. But, anything less than it, or any further delay in giving debt relief can trigger a more fateful spate of destabilising mishaps in the Chinese economy.
The government has therefore, proposed to take a multi-pronged approach for cutting company debts, including encouragement mergers and acquisitions, bankruptcies, debt-to-equity swaps and debt securitisation by issue of new guidelines by State Council, or
the Cabinet. Though, international institutions have been warning Beijing since long to stop financing weak firms, especially the inefficient state-owned enterprises, which often tended to crowd out, the private sector. In spite of these warnings China has hitherto failed to curb excesses in its credit system and
therefore, now it faces mounting risk of a full-blown banking crisis. As per a key gauge of the Chinese credit vulnerability, it is now three times over the danger threshold and continues to deteriorate, despite pledges by Chinese premier Li Keqiang to wean the economy off
debt-driven growth before it was too late.
As per the Bank for International Settlements, China’s “credit to GDP gap” has reached 30.1, the highest to date. It is much more and significantly higher than the scores in East Asia’s speculative boom on 1997 or in the US sub-prime bubble before the Lehman crisis. China’s total credit had also reached 255% of their GDP at the end of last year with a jump of 107 percentage points over last eight years. This is an extremely high level for a developing as well as developed economy and is still rising fast. Outstanding loans of China have reached to $28 trillion, as much as the size of commercial banking systems of the US and Japan combined. The scale is enough to threaten a worldwide shock if China ever loses control.
High debt levels have added to
operating difficulties for some Chinese firms, increasing their debt risks, as per statement of the National Development and Reforms Commission (NDRC) of China, released during a news briefing in Beijing. Therefore, the NDRC has announced that “market-oriented
debt-to-equity swaps will be one of the important measures to reduce corporate leverage”. The NDRC’s vice chairman Lian Weiliang has asserted it during the news briefing. It is indeed a very
revolutionary proposal to convert debt into equity and relieve the ailing
companies from servicing unsustainable debts. Though, Lian has also warned that the swaps are not a “free lunch” for troubled companies, clearly adding that loss-making “zombie” firms are strictly forbidden from such exchanges, which will be used mainly to help high-quality firms that face temporary difficulties. He also clarified that the government will not be responsible for any losses occurred during the swap process in a bid to prevent “moral hazard”.
Unfortunately, China‘s another major crisis brewing in the economy is that the bond markets have also worked hitherto for years on the assumption that issuers were effectively guaranteed by the state. Of late, since 2014, though, Beijing has been cautiously trying to change that perception by allowing some issuers to default. Such bond defaulters are also growing in number Bond yields in the major economies normally track the growth rate of
nominal GDP, but they are now far lower in China. Roughly, $10 trillion is trading at negative rates and this has spread into corporate debts as well.
China also proposes to combine deleveraging with over capacity
reductions, and the government will also provide preferential tax treatment to help firms cut debt levels, as per
official’s statements. The central bank is also expected to create a favorable
monetary policy environment for this debt reduction as per Fan Yifei, a Vice Governor of the People’s Bank of China. Banks will also be encouraged to transfer bad loans to asset management companies and push forward the
securitisation of bad assets, in
pursuance with Cabinet guidelines. Since, the banks can never be forced to conduct the swaps, so it is being said that the government will prevent a shift of risks from non-financial firms to banks under the debt-to-equity swaps. But practically it is being done so.
China had earlier also experimented with debt-to-equity swaps in the late 1990s as part of its sweeping reforms in the state sector that led to around 28 million layoffs over five years then. But, experts say this programme had made state-owned firms less willing to find ways to pay back debts.
One bright spot is a repayment of foreign debt denominated in dollars. Cross-border bank credit to China has fallen by a third to $698bn since
peaking in late 2014 as companies have scrambled to slash their liabilities before the US Federal Reserve raises rates. But, China’s problem is its
internal credit. The risk is that a fresh spate of capital outflows might force the central bank to sell foreign exchange reserves to defend the exchange rates of yuan, automatically necessitating
tightening of monetary policy. But, in spite of all the measures underway yet China is emerging as the epicenter of risk, vulnerable to face a full blown banking crisis any time. But if the way people in India and abroad have started renouncing and boycotting Chinese products, the debt cuts would also not save the Chinese economy from a ceaseless spate of corporate failures and a consequent full blown banking and monetary crisis. And in all probability, they are going to complicate. n