The abandoned Qingquan Steel plant, which closed in 2014 and became one of several so-called "zombie factories" operated by China’s state-owned enterprises. Photo: Getty Images by Kevin Frayer
China’s policy makers seem to be prepared to wage wars on long-term loss making firms, mainly state-run companies in industries that have reached overcapacity. The debt-ridden businesses that pose a threat to China’s broader economy have been called by the media as ‘zombies’.
Policy researchers with the National Development and Reform Commission (NDRC), China’s economic planner, were quoted as saying this Wednesday that the country would “proactively address the problem of overcapacity and strictly implement policies to clear ‘zombie enterprises’.” Observers believe phasing out overcapacity is systemic work; and the government would step up efforts to clear zombies in the second half, with concrete action plan coming soon.
Going into overdrive
China’s central government has realized that addressing overcapacity and debt problems of unprofitable state-run firms key to its restructuring efforts to a more sustainable economy. Besides, China is also pressured to stop supporting producers that are flooding world markets with unwanted goods as slack demand drags on the world economy.
Last December, Premier Li Keqiang was quoted as saying that the process to clear up zombie companies will take two years, and indicated the authorities were preparing themselves to tackle the problem. "The government will use assets reorganization, equity transfers, closure or bankruptcy to dispose of companies that have three consecutive years of losses and don't fit in with the direction of the government's industrial restructuring," said a statement released after a State Council meeting chaired by Li. It is regarded as the first public mentioning of a timetable for the initiative.
Based on the latest data, the first half of 2016 has seen overcapacity in the iron and steel industry reduced by over 13 million tons, 30% of the total volume targeted for the whole year. During the same period, the coal-mining industry has cut off 72.27 million tons, achieving 29% of 0.25 billion-ton target.
Vice Minister Feng Fei with the Ministry of Industry and Information Technology (MIIT) said recently, “The primary goal for the first half year is to set tasks, while the second half will see more implementation, which would bring (our work) to a new phase.” The MIIT supervises industrial enterprises and their operation through formulating and implementing policies concerning industry development.
Recently, it was also reported that China’s national assets watchdog, the State-owned Assets Supervision and Administration Commission (SASAC), and economic planner, the National Development and Reform Commission (NDRC) have separately held meetings about reducing overcapacity in heavy industries including iron and steel, and coal-mining. It is expected that a specific timetable and list of tasks would come out soon.
The NDRC would coordinate with the MIIT to roll out concrete plans to dispose of zombie firms, while the SASAC also formulated implementation plans targeting central SOEs that are zombies.
Considering all the upgraded actions taken by related agencies, it is clear that the central government’s push for clearing zombies has reached a critical juncture, and people will see policies and plans being carried out in the second half. The axe will finally fall on them.
Despite that, there remains a widespread concern about China’s resolution to take knife to the state-run businesses that have long been hailed as a guarantee for local fiscal revenue and employment.
A Wall Street Journal report entitled “China’s zombie companies stay alive despite defaults” used the example of Dongbei Special Steel Plant, China’s largest producer of special steel, to make the argument. The steelmaker with 70% ownership belonging to Liaoning provincial government defaulted on its first bond payment on March 28. Although it is unusual for the central government to allow such large state-run businesses to acknowledge default, till now, the loss-making enterprise has missed seven bond repayments in a few months and nothing has happened to it.
Dongbei “has yet to formally file for the equivalent of bankruptcy protection, close unproductive units or start a restructuring of its operations,” wrote the report.
Report on ‘zombie companies’
China’s first investigation report on ‘zombie companies’ came out recently, indicating that a high percentage of zombies are big state-run businesses. The report also acknowledges the side-effects of the 4-trillion-yuan economic stimulus in 2008, local government-business collusion and credit discrimination as the main causes of the economic woes.
On July 27, the Investigation Report on Chinese Zombie Firms—Facts, Causes and Solutions was released in Beijing by the Renmin University of China that comprehensively studies zombie companies in China.
The investigation is based on data on China’s industrial enterprises between 2005 and 2013, which had tracked 800,000 companies and collected 3.6 million observations. Another database on listed companies between 1998 and 2015 was also referred to.
The report found that between 2005 and 2013, around 7.51% of businesses in the industrial sector are ‘zombies’, among which, most are state-owned or collective, medium or large-scale. The top three industries especially affected by zombies are steel, real estate and architectural ornament.
Characteristics of zombie firms
Although Premier Li Keqiang has defined zombies as those that “have three consecutive years of losses and don't fit in with the direction of the government's industrial restructuring”, the Renmin University report notes it is using a different method to more accurately identify zombie firms. “If a company has been identified as zombie by the FN-CHK method in the year and the year before, it is a zombie company, meaning interest rates on loans taken by the company is lower than the minimum rates in the market in normal times.”
The report found that between 2000 and 2013, the number of zombies peaked at around 30% in 2000, and then it dropped to a stable level since 2004. It’s known that the first round of aggressive reforms on SOEs started from the end of 1990s and ended around 2004. The reform is commonly regarded as considerably increasing the efficiency of state-owned firms despite mass layoffs.
From 2005 to 2013, the share of zombie firms in the industrial sector remains at around 7.51%. The report notes that the risks of zombies is being gradually mitigated, while also noting that there has been an increase in the number of zombies since 2012 when the side effects of the 4-trillion-yuan stimulus began to show.
The industries with the highest proportion of zombies include steel (51.43%), real estate (44.53%), architectural ornament (31.76%), commerce and trade (28.89%), while industries with the lowest proportion are media (4.12%), non-banking finance (4.65%), IT (5.23%) and leisure services (5.88%). The banking sector has no zombies.
As for regional distribution, the report found that in more developed eastern and southern provinces like Shandong, Jiangsu and Zhejiang, there are more zombie firms, though the problem is not so serious thanks to a strong economic base. While in China’s less developed areas in northeast, northwest and southwest, although there are fewer zombies, local economies are more severely affected. And the phasing out or shutting down work would be challenging considering local economy and structural problems that would leave laid off workers nowhere to go.
The silver lining is, according to the report, compared with the 2000-2004 period, companies that joined the ranks of zombies after 2005 seem to better adapt to reorganization and restructuring, meaning China’s government has become more skillful in handling the restructuring.