BEIJING/WASHINGTON – China is not just contending with falling stocks, a plunging currency and a slowing economy.
It has vampire trouble, too.
The Chinese economy is pock-marked with companies that cannot pay their bills and survive only with government help. Jiangshi, the Chinese call them — “vampire companies.” Or zombies.
These ghoulish companies and their debts are hindering the world’s second-biggest economy and will likely do so for years. Companies that miss debt payments inflict losses on banks, which then find it hard to lend even to solid companies. By propping up vampire companies, the government can weaken the entire economic ecosystem.
All of which helps explain why the global economy is sputtering and why investors have been gripped by panic.
“It’s undoubtedly a very serious problem,” says Charles Collyns, chief economist at the Institute of International Finance. “The Chinese so far have been very reluctant to let market mechanisms work their way.”
On Friday, as finance ministers and central bankers of the Group of 20 major economies began meeting in Shanghai, Zhou Xiaochuan, head of China’s central bank, insisted that Chinese authorities closely monitor debt loads. Even so, he said he expects China’s economy “to grow at a moderate-to-high pace.”
The debt buildup is vast. Chinese corporations excluding financial companies had amassed $14.5 trillion in debt by mid-2015, up 4½-fold from eight years earlier, according to the McKinsey Global Institute.
That debt equaled 131 percent of China’s gross domestic product, up from 76 percent in mid-2007. That is nearly double U.S. corporate debts’ share of U.S. GDP, McKinsey says.
China’s total debts — everything owed by corporations, households, government and financial firms — climbed from $6.6 trillion in mid-2007 to $31.9 trillion by mid-2015. It equals 290 percent of China’s GDP, McKinsey says — astoundingly high for a still-developing economy.
When banks lend with a frenzy, they tend to make blunders as they shovel money to companies that can’t repay. Buried in bad loans, banks tend to curtail the credit that’s vital to growth.
For years, China’s debts remained fairly stable. But they surged after Beijing delivered a huge stimulus program in 2008 to fight the global recession. Under orders, state-owned banks pumped out loans. And local governments piled up debt to finance the construction of low-income apartments, roads and other projects meant to juice growth.
By keeping China’s economy humming, the stimulus program helped energize the global economy. And it added little to Beijing’s own debt because it appeared on the books of banks and state-owned companies. Some loans financed factory construction in poor regions or development in areas with disadvantaged ethnic groups.
Now, the debt is returning to haunt China.
Still, the debt is not likely to ignite a financial panic like the one that paralyzed Wall Street in 2008 and closed Greek banks. China will not have to beg foreign creditors for a bailout in exchange for growth-killing spending cuts and tax hikes.
“This is not a Greece-like situation,” says Susan Lund, a partner at the McKinsey Global Institute. “Only 5 percent of Chinese debt is owed to foreign creditors.”
Beijing has enough money to absorb a load of bad debts and avert a catastrophe. Yet the debts will likely hobble its economy for years. The problem, says Ruchir Sharma of Morgan Stanley Investment Management, is not just the magnitude of the debts. It is also the speed with which China accumulated them.
Sharma and his team reviewed what happened to 30 countries that quickly ran up private debts after World War II. It was not pretty. All suffered sharp slowdowns. He suspects that China’s economy is headed toward 4 percent annual growth from the 6.9 percent the government reported for 2015.
Most economists are not as pessimistic. But there is widespread suspicion that China’s official numbers overstate growth.
The China Banking Regulatory Commission says bad loans are “generally under control” and account for just 1.67 percent commercial bank loans.
Many analysts are dubious.
“No serious person thinks it’s less than 7 or 8 percent,” says Harvard University economist Kenneth Rogoff. “The question is, is it actually 10 to 15 percent?”
Debt-burdened companies face another threat: Falling prices, which raise their inflation-adjusted borrowing costs. Jason Thomas of the Carlyle Group investment firm says Chinese companies involved in construction, mining and manufacturing are often paying inflation-adjusted loan rates above 12 percent.
Economists say China must let uncompetitive companies die and write off their debts. In developed economies like the United States, it is common for companies to fail or to use bankruptcy laws to restructure.
Beijing says that is what it wants to do. In January, Zhang Yi, who oversees state-owned properties, vowed to weed out “zombie” companies by 2020.
Easier said than done — especially in a country where uncompetitive companies with big debts are often owned by the government or have powerful connections. Officials are tempted to intervene to rescue vampire companies, partly to save jobs.
The state-owned steelmaker Sinosteel has repeatedly been allowed to postpone its payments to bondholders. The government of Yunnan province intervened in November to avert a default after the state-owned Yunnan Coal Chemical Industry Group ran short of cash to pay bondholders.
And the Yunnan government restructured Yunnan Coal’s debt and is monitoring its finances, according to Yunnan Yunwei Co., a unit of Yunnan Coal.
In the meantime, the debt keeps rising. China reported 1.94 trillion yuan ($298 billion) in new corporate loans last month, up 85 percent from a year earlier, Barclays notes.
Local and provincial governments have a perverse incentive to let zombie companies stagger on, notes Minxin Pei, a government professor at Claremont McKenna College: In an economy with too many companies, those that outlast the competition eventually stand to win.
“If I kill my zombie and you don’t kill yours, I sacrifice,” Pei says.
Eswar Prasad, a Cornell University professor and former head of the International Monetary Fund’s China division, cautions:
“A lot of the debt has gone to finance unproductive investment in sectors where there is already a lot of excess capacity. There will be a big price to pay eventually to clean up these debts.”
Beijing wants to find a way out. It has pushed companies to merge. It let China Shanshui Cement Group, a cement maker, default on a bond — part of an effort to press Shanshui into being absorbed by a rival.
Another government effort was less successful: Last year, state media urged ordinary Chinese to buy stocks. The idea was that those purchases would lift share prices, allowing troubled companies to issue new stock and use the proceeds to shrink debt.
For a while, it worked. The Shanghai Composite Index jumped nearly 70 percent from February through mid-June 2015. Then the bubble burst. The Shanghai stock index is down 22 percent this year and 46 percent from its peak.
China has killed off zombie companies before. The reformist Premier Zhu Rongji cut off lending to inefficient state-owned companies, forcing many out of business and wiping out 35 million jobs between 1998 and 2002. But a booming economy — average annual growth topped 8 percent in those years — allowed many of the laid-off to find new work or to retire and rely on children with jobs.
Things will be tougher with economic growth dipping toward 6 percent — or lower.
“The odds of China having a sharp slowdown — say to 3 or 4 percent — are pretty high,” warns Rogoff, a former chief economist of the IMF. “They’re in a risky situation.”