Chinese banks have dramatically reduced pressure on some of the country’s most heavily indebted state-owned enterprises with a slew of debt-to-equity swaps across a range of industries.
State media outlet China News Agency cited data from the National Development and Reform Commission indicating that Chinese banks have used debt-to-equity swaps to reduce the aggregate debt levels of over 70 state-owned enterprises in the steel, coal, chemicals and equipment manufacturing industries by as much as 1 trillion yuan (USD$149.2 billion).
China launched a concerted deleveraging campaign towards the end of 2016 to deal with the burgeoning mountain of debt accumulated since the Great Financial Crisis. Much of this debt is concentrated in the state-owned enterprise sector, to which China’s bank-dominated financial system is heavily beholden due to the influence of policymakers.
This set of circumstances prompted President Xi Jinping to declare the deleveraging of state-owned enterprises to be the “priority of priorities” at China’s recent National Financial Work Conference in mid-July, in order to protect the financial system from potential defaults by the public sector’s many ailing or inefficient companies.
According to data from the Bank of International Settlements China’s 2016 corporate debt rose to approximately 170% of GDP in 2016, from 100% in 2008, while the aggregate debt of both SOE’s and private corporations was USD$15.7 trillion last year.
A recent report from Goldman Sachs points to a slowdown in Chinese bond defaults in 2017, with earning improvements helping to ease the debt pressure on corporations at the start of the year.
China previously used debt-equity swaps to tidy up bank balance sheets in the 1990’s, while Li Keqiang mooted revival of the instruments to deal with the country’s current leverage dilemma at the National People’s Congress in March 2016.
Following the breakneck development of the Chinese economy over the past two decades however, the use of debt-equity swaps this time around has been characterised by greater use of market mechanisms, in order to prevent funds from being channelled to moribund “zombie” enterprises on the brink of collapse.
Banks and other financial institutions have been given greater latitude to select with which companies they would enter debt-equity swap agreements, as well as the terms of such arrangements.
ING Bank NV economist Iris Pang said to the South China Morning Post that the new requirement that locally incorporated commercial banks hold at least a 50% stake in debt-to-equity swap units will abet use of the instruments for deleveraging by shielding them from political pressure.
“According to the latest draft rules, banks will hold more than 50 per cent stake of the unit that handles the swap, which means they will have a bigger say for the projects,” said Pang.
“That’s a good sign. It partly eases the concern of the market that banks would be under pressure from local governments if they are just minority stakeholders.”