October 10, 2016
State Council issues guidelines on swapping bad debt to equity
IMF has flagged the potential threat from growing debt pile
China released guidelines for reducing corporate debt while also saying that the government won’t bear the final responsibility for borrowing by companies, the latest sign that policy makers are stepping up their fight against excessive leverage.
The State Council, China’s cabinet, issued guidelines for reducing corporate debt and for how banks may swap bad debt to equity. At the same time, officials from the central bank and other government regulators held a briefing at which they described corporate leverage as high among major global economies.
The International Monetary Fund has flagged the potential threat China’s growing debt pile may pose to the banking system and global growth. While challenges are still manageable, “urgent action is needed to ensure that they remain so,” James Daniel, the fund’s mission chief for China, said in August.
China’s total debt grew 465 percent over the past decade, according to Bloomberg Intelligence. Total debt rose to 247 percent of gross domestic product in 2015, from 160 percent in 2005, with corporate debt jumping to 165 percent of GDP from 105 percent.
Policy makers also acknowledged the potential risks associated with the new initiatives. Officials will closely monitor financial risks caused by cutting corporate debt to prevent cross-market contagion, according to the State Council guidelines. Banks will face some losses during the swap and history shows in other countries that some debt swap plans may fail, China Banking Regulatory Commission Vice Chairman Wang Zhaoxing said at the briefing.
With China’s economy stabilizing for now and forecast by economists to exceed the government’s 6.5 percent growth target for this year, policy makers do have some buffer to step up the reforms. The credit surge that started in late 2014 has underpinned growth and also led to a further buildup in borrowing that has increased debt and fueled excessive housing price gains in major cities.
“The measures are conducive to reducing the systemic risks in the financial sector, and are very timely,” said Wen Bin, a researcher at China Minsheng Banking Corp. in Beijing.
PBOC Governor Zhou Xiaochuan said over the weekend at the IMF-World Bank annual meetings in Washington that while bad loans have increased in China, risks are controllable and policy makers will curb credit growth, according to a statement from the central bank.
The announcements came in two statements from the State Council as well as a third distributed at the briefing. The event included a phalanx of speakers in addition to Wang: People’s Bank of China Deputy Governor Fan Yifei, State-owned Assets Supervision and Administration Commission Vice Chairman Meng Jianmin, Assistant Finance Minister Dai Bohua and National Development and Reform Commission Vice Chairman Lian Weiliang.
Such multi-agency coordination is one of the bright spots of the initiative, according to Ming Ming, head of fixed income research at Citic Securities Co. in Beijing. “Regulators of banks, SOEs, and industries are all parties with a stake, and should work together to solve the problem,” he said. “Otherwise deleveraging can never be truly realized.”
Some businesses now face worsening debt risks and greater operating difficulty, according to the statement released at the briefing in Beijing. Debt-to-equity swaps must protect shareholder rights and their prices should be market based, Lian told reporters.
For the debt-equity swaps, the State Council proposed a market-oriented process driven by borrowers, lenders, and independent agencies responsible for the conversions. They will decide which borrowers will qualify to participate, the pricing, funding sources, and exit strategies, the cabinet said in a statement .
Still, the council stressed that the program can only be applied to borrowers with good prospects such as marketable products, advanced technology and relatively sound credit. So-called “zombie firms” with no future, companies that tried to evade paying debt, and those that worsen overcapacity may not take part, it said.
Banks can’t convert debt into equity directly, and instead must transfer it to an “execution agency” to conduct the conversion, the State Council said. The government is encouraging asset managers, insurers, state-owned asset firms, as well as qualified units at banks to become such agencies to execute the deals with funds raised from public investors, including selling financial bonds.
With plans to address corporate deleveraging, policy makers in China can point to progress in all three areas they’ve listed earlier this year key goals in supply-side reform: cutting excess capacity, easing housing inventories and reining in corporate debt.
NDRC Chairman Xu Shaoshi told Bloomberg Sept. 30 that China could complete overcapacity cut targets for steel and coal sectors earlier than expected by the end of the year.
Local governments across 21 cities including Beijing, Chengdu and Suzhou have recently tightened rules for home buying to cool overheated property market and ease concern that related credit expansion will add risk to the financial system.
— With assistance by Yinan Zhao, Jun Luo, and Miao Han
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