BOFIT Weekly Review 2016/17
IMF concerned about state of Chinese businesses
The IMF’s April 2016 edition of its Global Financial Stability Report finds that at the end of last year nearly 16 % of Chinese companies borrowing from commercial banks had less revenue than their interest costs. The IMF puts the amount of potentially at risk bank loans to corporations at $1.3 trillion or 12 % of GDP. That amount rises to about $2 trillion or 18 % of GDP, when loans channelled through the shadow banking sector, policy banks and the off-budget financing vehicles of local governments are included. Not all at-risk loans end up as bank losses, of course, because corporate profitability may recover or the shortfall made up by e.g. selling off company assets. The rapid growth and sheer volume of potentially at risk loans, however, has triggered alarms regarding the state of China’s business sector.
There are other signs of the weakened condition of Chinese businesses. The average time of it takes to settle intercompany payments has soared in the past year, and the practice of companies using their own shares as collateral for bank loans has become widespread. The IMF says that the value of equity used to secure bank loans was $460 billion at end-2015, a 30 % increase from July 2015. Moreover, the report notes that the use of equity as collateral is among the financial measures companies use as the last resort.
The origins of the current struggles of Chinese businesses can be traced to the provision of cheap loans in particular to state-owned enterprises to finance unprofitable projects. As company profits have declined, it has become harder for these companies to service their loans. Problems have emerged in real estate, manufacturing, mining, steel production, as well as in the retail and wholesale trade sectors.
Despite rising debt, the IMF says China has sufficient buffers to handle the situation. Banks are still showing healthy profitability and have sizeable reserves. If needed, the central government can afford to help resolve banking sector problems. The IMF emphasised, however, that officials must take prompt action now to break China’s debt spiral before the situation gets out of hand. The IMF would most like to see improvements in risk management practices and banking efficiency, whereby reasonably priced lending is directed to healthy firms for viable projects. It also suggests banks should write down their loan losses sooner and called for an end to market-distorting implicit government guarantees to state-owned enterprises.