China's state-owned enterprises embellish financial data while resisting capacity cuts

According to a report released last week by China's National Audit Office, 18 out of 20 state-owned enterprises (SOEs) provided falsified financial figures to auditors. Revenues and profits were exaggerated through fictitious payments, arcane payment arrangements and manipulated financial statements. Some of the audited SOEs were among the largest businesses in China.

Media reports mention that the audit report also critiqued SOEs for violation of official Communist Party policy. Many of the audited firms failed to close down their loss-making "zombie" firms and resist dealing with their overcapacity issues. The report also criticised the backsliding of local governments on overcapacity problems and rapid increases in indebtedness.

While the overstatement of profits by the audited firms represented less than 2 % of their profits overall, the financial statements show how the career paths of upper management in state firms face the same perverse incentives as local administrators. Many provinces have recently been shown to give rosier pictures of their financial development than reality warrants. Part of the problem also stems from China's rigid growth targets in conditions where the emphasis should otherwise be on reform policy. This burdens local governments and SOEs with conflicting expectations.