Opinion

‘Old China’ bad, ‘New China’ good: Growing divergence in Chinese corporate health

Divergence in debt levels and corporate health in China is growing, with many state-owned companies still stuck in the past and new industries such as tourism and healthcare overtaking the old ones. While fiscal and monetary stimulus may temporarily cover up the problems of companies in the old industries, a restructuring of these sectors seems inevitable.

By: Date: July 26, 2016 Topic: Global Economics & Governance

This op-ed was originally published in BRINK.

BRINK news

Chinese debt is a hot topic right now, competing with the likes of Brexit and presidential hopeful Donald Trump to play the role of boogeyman for global investors. It’s hovering in the peripheral vision, a risk that is worrying but difficult to assess.

It may seem surprising, therefore, that at 86 percent of common equity, the total debt of China’s 3,000 largest listed companies, is just over half the level of the world’s 3,000 largest listed companies, according to our recent study, the Natixis China Corporate Debt Monitor.

But numbers can be deceiving (particularly averages), and investors would be wise to look into the details if they want to avoid the devil.

Sticking with the sample of 3,000, we found that, while less indebted than global peers, Chinese companies are having a harder time paying the interest on corporate debt, primarily due to weak revenues in a slowing economy, riddled with excess capacity and inefficient assets. These Chinese companies also have much more short-term debt on the balance sheets, meaning they will need to pay off—or more likely, roll over—loans sooner.

Figure 1 Alicia BRINK

Under such a scenario, investors may be tempted to stick with the largest Chinese companies as the most stable, but once again, a poke into the numbers gives cause for more caution in one’s asset allocation.

We split out the 100 largest companies from our sample and found these to be the most vulnerable of the lot, with much higher leverage and less ability to pay interest on their loans. This is particularly true of the private sector, which is dominated by highly leveraged real estate companies, a full third of which have insufficient earnings to pay the interest on their debt load.

What about state-owned enterprises then? Could they provide a safe haven? It is true that, with their explicit or implicit government guarantees, they enjoy longer loan terms from banks than their private-sector brethren. As New China emerges, state-owned enterprises (SOEs) are, by and large, still stuck in the past. Broken down by assets, almost 80 percent of SOEs are in “old industry” sectors such as infrastructure, chemicals and energy, compared with 65 percent of companies in the private space.

If investors do want to stick with SOEs, they would be advised to go big, as the smaller- and medium-sized among them are, in general, more leveraged and less able to pay their interest. The picture is reversed in the private sector, however, where the largest companies are generally weaker because of the real estate dinosaurs.

Overall, looking across private and state-owned companies, a clear picture emerges that illustrates the clear and growing divergence in corporate China today. Put simply: Old China bad, New China good.

Real estate—the New China of yesteryear—is joined by the largely state-owned sectors of infrastructure (chiefly construction), materials, metals and chemicals as the worst of the bunch. Here, overcapacity reigns, profit margins are withering and companies are struggling to pay their interest, even as debt continues to pile up.

‘New China’ Offers Investors Better Path Forward

For more promising pastures, investors should look past these lumbering old world behemoths to the New China companies embodying President Xi Jinping’s vision of the country’s future economy. Three sectors in particular stand out: airlines, tourism and healthcare.

Figure 2 Alicia BRINK

Airlines have a lot of debt, at almost three times their equity; however, this is the industry norm worldwide, while the Chinese players enjoy longer loan terms than their global peers (they are largely state-owned) and are more profitable. They are also in a growth market, as more and more Chinese enter the middle class and start to take vacations.

In a similar vein, tourism-related companies, which are mostly from the private sector, are generally sound. A worrying 20 percent of them are what I term “zombies”—companies unable to pay their debt from earnings—but on the whole, they are more profitable than their global cousins, with manageable debt levels at 60 percent of equity.

Our star performer is health care, where profit margins of 12 percent far outstrip the global average of 8 percent, and debt is less than 50 percent of equity, compared with almost 120 percent globally. Short-term liabilities are high, at 86 percent of total liabilities—as banks are less willing to lend long term to this sector of young, mostly private enterprises—but more than 97 percent of the companies are able to pay their interest from earnings.

The significant divergence in debt levels and corporate health in China can be traced back to the four trillion yuan stimulus package of 2008-2009, when the government pulled out all the stops to save the economy, flooding the country with credit that washed largely into the old industry firms. These companies did what they were expected to do and grew rapidly, using the cheap money to expand production capacity that had little use once demand faded away with the stimulus package.

The New China sectors, by contrast, were largely overlooked in 2008-2009 credit binge, explaining their lower debt levels today and the relative health in the supply demand balance of their industries. The soundness of these New China sectors is certainly reassuring, implying that the economic drivers of China’s future have fuel in the tank and a clear road ahead; however, these sectors are still far too small, accounting for just 27 percent of companies by assets, compared with almost 50 percent for the same sectors globally.

To put the scale of the challenge in context, our top three New China sectors, identified above, account for just 3 percent of total assets in our sample, while the worst three Old China industries account for a whopping 43 percent. The road to New China is a long one, indeed.

To make matters worse, China’s central bank is now embarking on a new credit spree, employing ultra-lax monetary policies that have resulted in new loans in China passing a breathtaking 4.5 trillion yuan in the first quarter of the year, equaling the record set during the height of the last stimulus package in 2009. It is the dinosaurs that are once again hogging the punch bowl, with new loans to real estate hitting 1.5 trillion yuan in the first three months of 2016, almost double than at the peak of the 2009 binge.

Large companies are the major employers in China and the government is clearly intent on preventing serious defaults and the instability these would bring. While monetary and fiscal stimulus may ease the symptoms for these old industries, more cheap credit will only make the eventual restructuring that clearly beckons even more painful. Meanwhile, buying time for the old sectors pushes the coveted rebalancing out into the future, making the dream of New China ever more elusive.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article
 

Blog Post

Will European Union recovery spending be enough to fill digital investment gaps?

The recovery facility will boost digital transformation, but questions remain whether it will be sufficient to achieve Europe’s digital ambitions.

By: Zsolt Darvas, J. Scott Marcus and Alkiviadis Tzaras Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 20, 2021
Read article Download PDF
 

External Publication

Building the Road to Greener Pastures

How the G20 can support the recovery with sustainable local infrastructure investment.

By: Mia Hoffmann, Ben McWilliams and Niclas Poitiers Topic: Global Economics & Governance, Testimonies Date: July 15, 2021
Read article More on this topic More by this author
 

Opinion

Could the RMB dislodge the dollar as a reserve currency?

The dollar remains the world’s largest reserve currency, but it is facing both domestic and external risks.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: July 14, 2021
Read article More by this author
 

Blog Post

SPACs in the gap

Special-purpose acquisition vehicles could fill a gap in European equity markets and lure risk-averse investors off the sidelines.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 13, 2021
Read article More on this topic
 

Blog Post

A breakdown of EU countries’ post-pandemic green spending plans

An analysis of European Union countries’ recovery plans shows widely differing green spending priorities.

By: Klaas Lenaerts and Simone Tagliapietra Topic: European Macroeconomics & Governance Date: July 8, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

CCP's 100th Anniversary: Reflecting and looking forward

As the Chinese Communist Party celebrates its 100th anniversary, we looked into the past, future and present of the country's economic development.

By: The Sound of Economics Topic: Global Economics & Governance Date: July 7, 2021
Read article Download PDF More on this topic
 

Working Paper

Stability of collusion and quality differentiation: a Nash bargaining approach

How do incentives to collude depend on how asymmetric firms are? For low levels of differentiation, an increase in quality difference makes collusion less stable. The opposite holds for high levels of differentiation.

By: Thanos Athanasopoulos, Burak Dindaroglu and Georgios Petropoulos Topic: Innovation & Competition Policy Date: June 15, 2021
Read article More on this topic
 

Blog Post

The coming productivity boom

AI and other digital technologies have been surprisingly slow to improve economic growth. But that could be about to change.

By: Erik Brynjolfsson and Georgios Petropoulos Topic: Innovation & Competition Policy Date: June 10, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Challenges and growth of China's private sector

Is the dynamic role of the private sector in China under threat by its economic model and the United States?

By: The Sound of Economics Topic: Global Economics & Governance Date: June 9, 2021
Read article More by this author
 

Opinion

Inflation, inequality and immigration: Spelling the digital recovery with three “I”s

The digital transition offers us a new opportunity to reach out across the global economy - hopefully we will find the strength to use it.

By: Rebecca Christie Topic: Global Economics & Governance, Innovation & Competition Policy Date: June 3, 2021
Read article
 

Blog Post

For the climate, Asia-Pacific must phase out fossil-fuel subsidies

An exit from coal in the Asia-Pacific region is a global decarbonisation priority.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Energy & Climate, Global Economics & Governance Date: May 31, 2021
Read article More by this author
 

Parliamentary Testimony

House of Lords

The UK’s security and trade relationship with China

Testimony before the International Relations and Defence Committee at the House of Lords, British Parliament on the UK’s security and trade relationship with China.

By: Alicia García-Herrero Topic: Global Economics & Governance, House of Lords, Testimonies Date: May 27, 2021
Load more posts