Credit, steel dominoes line up in China

Cross-posted from Investing in Chinese Stocks.

A number of stories today capture the Chinese reform program nicely. The first, China SOEs Are Not Profitable, by Chen Duanjie at the University of Calgary’s School of Public Policy:

According to Unirule’s calculations, by taking into account only the unpaid rent for using public land and natural resources, the average real return on equity of China’s industrial SOEs as a whole was in the red (-1.47 per cent) for the period 2001-2009, compared to its reported return on equity of 8.2 per cent, which is still below the 12.9 per cent achieved by the non-SOE industrial sector in the same period.

A second article from Ifeng looks at why. It’s a roundup of opinion on China’s SOEs as they report earnings. One argument is that the firms earn little to no profits after accounting for unpaid rent, another says that without the government’s monopoly protection, the firms would be unable to earn a profit. Aside from real estate rental costs, there’s costs such as the spectrum licenses that the telecom monopolies receive for free. China’s government would earn as much revenue from the market, but likely more because of efficiency gains once the SOEs were forced to compete. The article doesn’t touch on another source of dubious profits, easy terms on bad loans, although the last opinion from Lin Yifu mentions the cost of funding on the rest of the economy.

But those easy loan terms are under pressure and private players are feeling it. The largest privately run credit guarantee firm in Sichuan has gone bust. 21CBH is reporting that the executives of Sichuan’s Huitong credit guarantee have “lost contact” and the status of ￥5 billion worth of loans are up in the air. The offices of the executives were sealed by police on July 9. The local government is temporarily taking over operations and has instructed the banks to continue working with the firm.

Huitong offered investors a 2% monthly return. There was no investment contract, only evidence from the firm that it received funds. Investors could take their money out at anytime, but two days advance notice was required. Investors say they have no idea where the money went, only that Huitong used it for credit guarantees. Another firm called Rongyuan Investment Management also accepted funds. They claimed to be a Huitong subsidiary, but receipts for funds invested didn’t have the company seal.

Huitong has worked with more than 20 banks, several trust companies and even public housing funds. The largest amount of the outstanding ￥5 billion in credit is bank loans, worth about ￥4.5 billion. The rest is with other firms, as well as some loans made directly by the credit guarantee firm. If some loans backed by Huitong are to other credit guarantee companies, legal action by the banks could result in yet more falling dominoes.

And SOEs are also tumbling. Xilin steel is the largest producer in Heilongjiang province and is on the verge of bankruptcy. Also from 21CBH, the firm was ￥19 billion in debt at the end of Q1. That ￥19 billion doesn’t seem like a large figure, but the Yichun economy is less than ￥26 billion. The local Yichun government extended a ￥40 million loan to the company and is currently working to have all relevant government departments and banks support the firm. The local government is unwilling to let the firm close because it contributes greatly to the local economy by way of jobs and taxes. According to one person close to Xilin Steel, Heilongjiang still has a large demand for steel and Xilin is one of only two major producers left in the province; another was purchased by a Liaoning steelmaker.

The article doesn’t delve into consolidation in the industry, but with consolidation seen as a solution to overcapacity, local and provincial governments are playing a game of survivor. The strongest firms will acquire and the weakest firms will go bankrupt or be acquired.

And thus will productivity return to China…eventually.

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About the author

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.