Who are the real zombies?
22 May 2018
Signs of corporate stress are emerging in China despite macro data showing relatively stable growth. Receiving most of the recent headlines has been the spate of corporate bond defaults and credit events, including nine companies (eight of which are private) that have defaulted on their debt this year. Regulatory tightening and curbs on shadow banking are partly to blame – credit flows have slowed and corporate borrowing costs have increased making it harder to refinance debts. But less noticed are other metrics which show declining corporate conditions, particularly for private enterprises. Profit growth has declined sharply, the asset-liability ratio for private firms increased to the highest level since records began, the number of private loss-making enterprises has risen sharply (state-owned loss-making enterprises have continued to fall), and days-sales-outstanding, a measure of cashflow, has risen for private firms despite falling for state-owned enterprises (SOE). Despite an abundance of data showing the private sector to be far more profitable and efficient than the state-owned sector, the fact is that private firms have benefited from China’s recent recovery far less than state firms. These trends raise questions about the creeping dominance of the state, and why, despite strong headline growth, private firms have struggled so much of late.
Recent data shows the stark differences in the outlook between state-owned and private firms. At the profit level, state-owned firms continued to see positive profit growth this year, while profits at private firms fell substantially in year-on-year (y/y) terms, down over 26% y/y in March. Diverging profit margins are one of the reasons behind the differing performance. In January 2017, profit margins at state-owned firms surpassed those at private firms and have continued to climb higher while margins at private firms have been falling since late last year, dipping to new lows. In addition to profits, other signals are pointing to rising stress among private firms. The amount of private firms classified as “loss-making” rose sharply from mid-2017 until March this year, rising from approximately 23,000 firms to 32,000; meanwhile, the number of loss-making state-owned firms continued to fall (see Chart 10). Private firms now make up approximately half of all loss-making firms. Lastly, asset-liability ratios, a measure of how much debt a firm uses to fund its business, have climbed sharply among private firms showing a greater reliance on borrowing while they have simultaneously fallen among state-owned firms (see Chart 11). We can observe the private versus state-owned firm divergence, but the main question is why?
One reason could be that the most of the growth last year and into this year stems from stimulus directed at (mostly state-owned) heavy industrial firms. Mining and processing of metals accounted for more than 70% of the growth in industrial profits last year, the remainder of Chinese industry saw profits grow by just over 2%. As we wrote in the past, most of the growth and stimulus of last year was anti-rebalancing, and it’s now increasingly evident that policies used to boost growth are having a detrimental impact on private firms. As policymakers are looking at how best to reforms SOEs, it has never been more evident that it’s not an ownership issue but a playing field issue.