Debt guarantee tangle: China’s private firms hit by default contagion

This photo taken on January 28, 2019 shows a worker checking wheels at a factory in Lianyungang in China's eastern Jiangsu province. China's manufacturing activity contracted for a second consecutive month in January, official data showed on January 31, another sign of the country's economic slowdown. (AFP)
Updated 12 February 2019
0

Debt guarantee tangle: China’s private firms hit by default contagion

  • As economy slows, banks wary of risky loans to private firms
  • Several well-run private firms file for bankruptcy

SINGAPORE: The collapse in China of a complex web of debt guarantees involving several private firms highlights risks in its financial system and opens up a potentially hazardous front for an economy in the grip of its slowest growth in nearly three decades.
It is the last thing Beijing needs as it tries to fight off intensifying pressure on growth from a months-long trade dispute with the United States. Yet, as the government steps up economic support measures and moves to loosen gummed-up funding, it might be inadvertently inflaming financial risks with its call on state banks to sharply boost lending to the private sector.
The warning bells are already sounding in the once-prosperous eastern city of Dongying, a hub for oil refining and heavy industry in Shandong province. Here, at least 28 private companies are seeking to restructure their debts and avoid bankruptcy, mainly due to souring loans that they guaranteed for other firms, court rulings seen by Reuters show.
Among the 28 firms are Shandong Dahai Group and Shandong Jinmao Textile Chemical Group, which were on the 2018 top 500 best-run private enterprises in China.
For a private firm to get bank loans in China, especially those in traditional, capital-intensive industries, it often needs substantial collateral or the guarantee of another company. The guarantor itself is very likely to have taken on loans guaranteed by other firms.
The private sector mess in Dongying highlights the inherent dangers in cross-guaranteeing of debt, with defaults quickly cascading across the system when one loan goes bad, threatening to disrupt local financial systems and new lending.
The concern is that Dongying is just the tip of the iceberg as cross-guaranteeing of loans is a common practice across China.
Private firms’ funding options are somewhat constrained because banks are reluctant to lend to the non-state sector, said Yang Zaiping, secretary-general of Beijing-based Asian Financial Cooperation Association, which comprises financial institutions from about 30 countries.
“There is a severe imbalance between private companies’ contribution to the Chinese economy and the financing that they get. They account for 50 percent of taxes, 60 percent of GDP, 80 percent of urban jobs and 90 percent of new hires, but only receive 25 percent of loans disbursed,” Yang, a former Chinese banking regulatory official, told Reuters.
“If private companies don’t have other sources of funds to repay their debts, or collateral, they have to find guarantees, which will add 2 to 3 percentage points to their financing costs,” he said.

Sting of cheap credit
As of end-June, Shandong Dahai had outstanding guarantees on 2.67 billion yuan ($394 million) of debt for 14 companies, according to a company filing in August. The total amount of guarantees was equivalent to 48 percent of its net assets.
Six of the firms have run into financial or legal trouble and two have been blacklisted by courts as “dishonest debtors” for their lack of creditworthiness.
Resource-rich Dongying, the site of China’s second-largest oilfield Shengli, used to be one of the country’s richest cities thanks to its vibrant private economy, boasting the highest income per capita in Shandong in 2017.
But excessive lending to local companies during boom times saw firms diversify into non-profitable, non-core businesses. So when credit conditions later tightened as Beijing embarked on a years-long deleveraging campaign, a series of loan and bond defaults in the region followed.
“Bad loans are often extended during good times,” said a Shandong-based official, who declined to be named.
The consequences are now clear. Two Dongying banks — Guangrao Rural Commercial Bank and Dongying Bank — have been hit by a sudden surge in non-performing loans.
Over 95 percent of Guangrao Rural’s bad loans were backed by guarantees, but the back-stop is mostly useless now because it was provided by firms that were heavily indebted and some had suspended production, according to a ratings report in May.
In Dongying, the local government has come to the rescue of the private companies by pushing through debt restructuring to avoid bankruptcy, said the Shandong-based official.
The Dongying government’s finance bureau did not respond to a request for comment. Officials at Shandong Dahai and Shandong Jinmao declined to comment.

To lend or not to lend?
China’s top banking regulator Guo Shuqing, one of the most powerful men in the financial sector, wants banks to double their funding allocation to private companies in three years — to 50 percent from 25 percent.
But faced with the rising default risks of private borrowers in cyclical sectors, and given their unsafe financing practices — from share-pledged loans to cross guarantees — banks are wary of lending to them.
Several bankers told Reuters they are keen to avoid repeating excessive and riskier lending that followed Beijing’s 4 trillion yuan stimulus package a decade ago.
Even though China has cut banks’ reserve requirement ratios five times since January last year, banks would rather use this freed up liquidity to buy “bonds at any cost” than give out loans, said a bank executive at the financial markets department of a joint-stock bank.
Private players are heavily concentrated in manufacturing and real estate whose bad loan ratios in these sectors have been much higher than the industry-average. Private companies were also the biggest defaulters last year, accounting for 126 of the total 165 bond defaults, according to Guotai Junan Securities.
And, as the economy brakes in the face of domestic and external pressures, with growth slowing to a 28-year low in 2018, the fear is that the cross guarantee practice exposes China’s financial system to a bad loan crisis.
“As growth slows and pressure increases on the economy, financial risks easily become contagious,” the Shandong official said.


Pakistan government ready to pay political cost to salvage sinking economy, official

Updated 22 April 2019
0

Pakistan government ready to pay political cost to salvage sinking economy, official

  • Pakistan in talks with IMF to bag $6-8 billion bailout program
  • Country’s financial experts expect thumbprint of IMF program on the upcoming budget

KARACHI: As Pakistan steps up efforts to negotiate loan program from the International Monetary Fund (IMF) before presenting federal budget for fiscal year FY20 next month, the top officials say the government is taking steps to salvage sinking economy, bracing itself for political repercussions.
Pakistan is currently negotiating with IMF expecting $6-8 billion loan program for stabilizing its wobbling economy suffering from current account deficit.
The country’s financial experts expect the upcoming budget to bear the thumbprint of IMF if a bailout is finalized before the budget is presented, which may not be before May 24, according to officials.
“As has been said earlier that the budget would be presented next month. Now we are taking steps that are not beneficial politically but we have to save the country and anchor the economy at a level where it does not further deteriorate. The situation is difficult but the government is trying to provide relief to economically vulnerable segment of society,” Syed Shibli Faraz, Leader of the House for the Senate of Pakistan, told Arab News on Monday.
“The government is cognizant of the fact that the recent gas and power tariff hike was painful for the masses and is now reversing its impact,” senator Faraz said adding that “lack of political will of the previous governments led to things reach an alarming state where ignoring them any further will lead to everything collapsing. It was because the previous governments did not comply with the IMF conditions.”
Talking about general perception that the IMF program will come with harsh conditionalities including additional taxes and expenditure curtailment that may slow the GDP growth rate, Faraz said, “I have also seen newspaper reports of PKR 600 billion to PKR 700 billion additional taxes [to be levied in the next budget] but I don’t know how we will do it?”
“However, the government will focus on broadening tax net instead of further burdening those who are already paying taxes,” he added.
Many economists question the wisdom behind such huge tax collection target when the fund has already downgraded country’s economic growth.
“When the IMF itself says that the growth would be around 2.9 percent then how such massive additional taxes could be generated from the depressed economy,” Dr. Ashfaque Hassan Khan, member of Economic Advisory Council, questioned while talking to Arab News saying “they are negating their own numbers.”
“This program will not work,” Khan warned. “I have repeatedly called for getting the plan B ready, which means aggressive import compression policy that requires less dollar and more focus on remittances.”
Pakistan is also fine tuning a new tax amnesty scheme to be announced to whiten the black money and facilitate documentation of undeclared assets hoping to collect huge sums. “We are expecting to collect a large amount and bridge the fiscal budget gap to some extent,” Faraz said.
In a major cabinet reshuffle recently, Prime Minister Imran Khan replaced country’s finance minister Asad Umar with Shaikh appointed as special adviser to the prime minister on finance, at a crucial time when Pakistan is in final stages of negotiating an IMF deal.
“Asad was working on solving basic structural issues of the economy but he become a victim of big lobbies,” Muzzamil Aslam, senior economist, told Arab News.
“Hafeez Shaikh is a technocrat who does not live in Pakistan and only comes in a ministerial position. He knows how to accommodate policies of international lenders without looking at the long term impact of their policies. He did not bailout or rescue any economy where he worked,” Aslam said.