MNI INTERVIEW: China Must Let SOEs Fail For True Deleveraging

--SOEs Roadblock to China's Pursuit of New Growth Model: Research Official

--Zombie SOEs Should Be Liquidated: Research Official

     BEIJING (MNI) - China must let failing state-owned enterprises (SOEs)

dissolve to realize its goal of containing debt levels and pursuing

consumption-driven growth, a top government research official told MNI in an

interview.

     "The soft budget constraints on most SOEs and their cosiness with state

banks lead to more debt that may never be fully repaid," said the official, who

declined to be identified as he is not authorized to speak publicly on the

matter. Without severing the links between SOEs and banks, the deleveraging

campaign won't make meaningful and enduring progress, he said.

     The comments came at a time when China's campaign to contain debt and root

out financial risks enters into a critical second year, even as officials were

quick to claim early successes. 

     According to PBOC's Monetary Policy Report published May 11, the macro

leverage ratio (outstanding debt of non-financial companies, governments and

households as percentage of the GDP) rose by 2.7 percentage points to 250.3% at

the end of 2017, compared with an average annual increase of 13.5 percentage

points in 2012-2016. 

     --LOW-HANGING FRUIT

     Yet the research official said the most critical and challenging part of

deleveraging has yet to come. What the government did in the first year was

simply picking the softer targets. 

     "Its easy to go hard on the private sector, but now the state must be

willing to discipline its own businesses," the adviser said.

     The SOEs, whose interests are intertwined with the regions where they

operate, have long been the most difficult and controversial challenge for

reform. About 62% of China's non-financial sector debt is held by the SOEs as of

the end of 2017, 3 percentage points higher than in 2016, according to National

Institution for Finance and Development, an authoritative think tank on debt. 

     SOEs are often spared from financial disciplines because local authorities

need them as sources of jobs and cash, including heavy subsidies channelled form

central government. Authorities are also quick to cite social stability to

justify efforts to keep them alive despite the economical unviability of some. 

     --MAJOR ROADBLOCK

     Much of the surge in SOE debt was amassed during the easing environment of

2014-2016. Outstanding debt held by SOEs at the end of March grew 8.7% over a

year ago to CNY106.6 trillion , according to Ministry of Finance data.

     Yet in the process of enforcing deleveraging and risk-prevention measures,

it was the private sector that bore the brunt of the austerity, the advisor said

to MNI.

     "Compared with the vulnerable private companies, SOEs can receive

low-interest funding even in a tight monetary environment due to the implicit

understanding that they are under government's backing," said the official.

     "In time of economic downturn and rising debt defaults, some financial

institutions chose to loan only to SOEs," he said. SOEs typically borrow at

rates 10% more than the benchmark loan interest rate, while private companies

are charged 30%, the researcher said.

     --"ZOMBIE COMPANIES"

     Policymakers therefore must be prepared to close more so-called "zombie

companies," entities that are economically unviable and operate on government

resuscitation measures, the advisor said. 

     According to State-owned Assets Supervision and Administration Commission

(SASAC), the ministry in charge of central government-owned companies, 400

zombie companies were eliminated last year. In practice SASAC often chose

restructuring, rather than liquidating, an approach that failed to address the

root causes, the advisor said.

     One approach pursed by both SASAC and local governments was selling

equities to investors in exchange for their debt under a government-sponsored

swap program. But these swaps are mostly not market-operated and cannot be

applied to companies with no hope turning around, the state researcher said. 

     "Zombie SOEs should die like private companies," the advisor told MNI.

Authorities cannot be both a regulator and a nanny, he said. Without addressing

this challenge, investors' confidence cannot be boosted and a new growth model

cannot fully take shape, he said. 

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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