They survive on a drip-feed of state subsidies and can suck the lifeblood out of a bloated workforce. Zombie companies live in the twilight world of China’s corporate jungle.
With heartbeats that can barely be detected, most of them lurk in the shadows of the sprawling state-owned enterprise sector, which employs more than 20 million people, and is the largest in the world.
Last year, a report compiled by the Organisation for Economic Co-operation and Development, or OECD, showed there were 51,000 SOEs in China valued at US$29.2 trillion. To put that into perspective, at the end of 2017 the country’s corporate debt was 159% of gross domestic product.
Tackling the problem has become a priority for Beijing, starting with the army of corporate zombies or companies which fail to generate enough revenue to repay their debts and are kept alive by state-backed funding. So far, nearly 1,200 SOEs have been shut down.
“We [have] reduced a lot of ‘zombie enterprises’,” Xiao Yaqing, the chairman of the State-owned Assets Supervision and Administration Commission, told the media at the World Economic Forum in Davos earlier this year. “Now, the management efficiency of the companies [has been] significantly improved.”
Yet more needs to be done with the economy cooling and the trade war with the United Sates escalating. Last week, Beijing stepped up efforts to rein in SOE excess, which accounts for roughly 60% of the country’s corporate debt, according to the government-owned China Daily.
Indeed, the build-up has been staggering.
Global management consultancy McKinsey reported that between 2007 and 2014, state and private companies went from owing $3.4 trillion to $12.5 trillion, which was the fastest rise in debt by a sovereign nation in modern times.
“State firms might account for only a quarter of the Chinese economy, but they’ve borrowed almost 60% of the country’s corporate debt,” Dinny McMahon writes in his new book China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle (published by Houghton Mifflin).
“China has little mortgage debt relative to the United States, and official government debt is very low, but China’s companies – and in particular its state-owned companies – have borrowed incredible amounts,” he stressed.
In a move to get to grips with the situation, Beijing has closed, merged or forced creaking SOEs to slim down after being weaned off a diet of overproduction.
President Xi Jinping’s administration has even launched a complex debt-for-equity swaps program during the past two years to help state companies borrow money to reduce investment shortfalls.
But while the scheme has proved popular, the People’s Bank of China, or central bank, has made it clear that funding “should not be used” to rescue “zombie companies.”
This, in turn, has come at a huge human cost. While data is sparse, between five to six million state workers will have become victims of the three-year cull by the end of 2019.
Nearly $23 billion has been put aside by the government to cover layoffs in the coal and steel industry, although the overall figure looks certain to be much higher as closures and mergers spread across the whole state-owned enterprise landscape.
“We hope there will be more restructuring and less bankruptcy … to let employees have more sense of gain – to have more job reallocation and fewer layoffs,” Xiao, of the State-owned Assets Supervision and Administration Commission, said during the National Congress of the Communist Party of China last October.
Still, the government is mindful of “social unrest,” two words which are rarely muttered in the corridors of power in Beijing but are at the forefront of the majority of policy decisions.
To ease the impact, the world’s second-largest economy has used the massive Belt and Road Initiative to solve overcapacity issues in heavy industry such as steel and aluminum production.
“There are evident economic advantages for the Chinese economy, the world’s largest exporter, in addressing domestic economic imbalances and industrial over-capacity (in manufacturing and construction), and in channeling excess savings and large foreign exchange reserves, particularly as domestic growth slows and the demographic dividend tapers off,” Shivshankar Menon, a distinguished fellow in the foreign policy program at the Brookings Institution, a Washington-based think tank, said.
Already these construction teams are beavering away on a wide range of projects that are part of the new Silk Road superhighways, connecting China with 68 countries and 4.4 billion people across Asia, Africa, the Middle East and Europe.
Again, while there is a lack of official data, the Belt and Road Initiative has been a boon for SOEs and their employees.
“Chinese projects are less open to local and international participation,” Jonathan E. Hillman, a fellow at the Center for Strategic and International Studies, another Washington-based think tank, said.
“Out of all contractors participating in Chinese-funded projects within the Reconnecting Asia database, 89% are Chinese companies, 7.6% are local companies (companies headquartered in the same country where the project was taking place), and 3.4% are foreign companies (non-Chinese companies from a country other than the one where the project was taking place),” he added.
There are also other risks lurking beneath the surface with accusations that the Belt and Road Initiative could turn into a giant ‘debt trap’ for nations participating in the project.
A short report by Thomas S. Eder and Jacob Mardell for Germany’s leading think tank, the Mercator Institute for China Studies, underlined the dangers when looking at investment in Central and Eastern Europe.
“The reality falls short of the rhetoric. Numbers on Chinese investments connected to the Belt and Road Initiative tend to be inflated and misleading,” MERICS reported earlier this month.
“Only a fraction of the reported sums is connected to actual infrastructure projects on the ground. And most of the projects that are underway are financed by Chinese loans, exposing debt-ridden governments to additional risks,” it added.
It seems the drip-feed of state subsidies is still being applied to the SOE sector to safeguard jobs. Only this time, it is dripping with new Silk Road money.