China cracks down on subsidies to zombie companies as US trade war hits economy

Frank Tang

As part of its goal to make the economy more efficient, China unveiled a new reform plan on Tuesday to make it easier for companies, including zombie state-owned enterprises, to be closed down.

The plan specifically forbids central government agencies and local governments from providing subsidies or loans to prop up the operation of state-owned firms that would not be financially viable without such help, which are known as zombie enterprises.

"For state-owned enterprises that already meet the criteria for bankruptcy, all related parties must not hinder their exit [from the market]," the circular said.

However, the final decision on whether a firm is solvent or not is usually in the hands of local officials, who often are reluctant to act given the importance of such firms to the local economy.

The reform plan was jointly released by 13 major ministries, including the National Development and Reform Commission (NDRC), the People's Bank of China, the Ministry of Finance, and the nation's Supreme People's Court.

Tang Jianwei, a senior analyst with the Bank of Communications, warned that local opposition to the closure of state-owned firms remains strong, given they are often large contributors to local employment and tax revenue.

The government also plans to set up an early warning mechanism for financial institutions and a legal channel that could be used for restructuring or bankruptcy, according to the plan. In recent months, China's financial regulators have had to take control of Anbang Insurance Group and the embattled Baoshang Bank to safeguard the Chinese financial system.

The government will also study creating a mechanism that allows Chinese individuals to file for bankruptcy, the circular said.

Numerous detailed regulations will be needed to implement the new bankruptcy policy, since closing industrial or financial companies requires significant changes in employment and disposal of large amounts of debt, Tang suggested.

"Amidst external pressure and changes in state capitalism, China still needs to improve its market mechanisms and business environment, open its market wider and integrate itself with best international practices" he said.

The announcement of the reform plan came just a day after the government reported that Chinese gross domestic product (GDP) growth slowed to 6.2 per cent in the second quarter of 2019, the lowest growth rate since records began in the first quarter of 1992.

The latest reform effort would, at least on the surface, seek to address some of the widespread complaints about China's dual-track economic system, where state-owned firms are often offered preferential treatment at the expense of private enterprises, even though the latter group contributes more than 60 per cent of the GDP and over 80 per cent of new urban jobs.

Private firms are more vulnerable to the current economic slowdown given restrictions on market access, constraints on their access to credit and the heavy impact of the trade war on the many private sector export firms.

On other hand, the dominance of state-owned enterprises, which usually control upstream resources and have access to cheap credit from state-owned financial institutions, remain largely intact despite the economic slowdown.

The State-owned Assets Supervision and Administration Commission, which oversees 96 large state-owned enterprises including the China National Petroleum Corporation and China Mobile, said it disposed of 1,900 zombie enterprises in 2018, but the country's huge stock of state assets and the expanding power of national champion enterprises are constantly questioned, particularly by US President Donald Trump as part of the ongoing trade war.

The bankruptcy reform plan is the latest effort by Beijing to reform the economy after it passed a new foreign investment law in March that would aim to create a more level playing field for foreign firms in China. It also scaled back the number of sectors in which foreign investment is restricted or prohibited.

Speaking at an economic analysis meeting on Monday, members of the Chinese People's Political Consultative Conference, the country's top political advisory body, urged the government to pursue further structural reforms to create new growth drivers so as to double the nation's middle-income population.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2019 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.