HONG KONG/SINGAPORE - Bankruptcies in China are likely to continue to rise sharply as the authorities become more accepting of them, and tighter financial regulation takes affect, Fitch Ratings said on Thursday (Aug 10).
But, fewer companies in sectors most needing restructuring have gone bankrupt, the ratings agency observed, adding that market forces continue to play a minor role in determining failures in the state-owned sector.
"There is little evidence yet that the government is willing to tolerate the job losses and the drag on economic growth that would accompany the bankruptcy of large 'zombie' enterprises, which are responsible for the most significant corporate inefficiencies and account for the bulk of overcapacity, it added.
Zombie enterprises are those that incur recurring losses and rely on the support of the government and state banks to survive. Resolving this issue would be a step towards improving corporate efficiency and addressing overcapacity, the release said.
The number of Chinese insolvency cases rose to 5,665 in 2016 from 3,684 in 2015, and is on track for another large increase in 2017, with 4,700 case filed in January-July alone, according to data from the Supreme People's Court. Cases resolved are also rising, reaching 3,602 in 2016 - up by 43 per cent from 2015 - and 1,923 in January-July 2017.
The increase in insolvencies is partly policy-driven with the authorities making efforts to improve the insolvency framework. Allowing market forces to play a greater role in determining bankruptcies should, over the long run, reduce moral hazard.
However, bankruptcies remain infrequent compared with other large economies.
Also, only 12 per cent of bankruptcies so far in 2017 involved companies in the highly indebted state sector, while only 10 per cent were from the real-estate sector where the National Academy of Development and Strategy has classified 45 per cent of companies as zombies. Only 2 per cent were in the steel sector, where over half of companies are considered zombies and overcapacity is a significant problem.
The authorities may continue to favour mergers of weak companies with stronger ones as a less disruptive alternative to outright bankruptcy for large enterprises, given that maintaining high and stable economic growth remains a primary policy target, Fitch said.
Local governments are also likely to continue supporting troubled enterprises that are sizeable employers in their localities.
SOEs employ over 60 million workers, but more than a quarter of them are unprofitable, based on official data. A concerted effort to wrap up non-viable companies would therefore almost certainly involve large-scale layoffs - the last major SOE reforms resulted in around 29 million job losses in 1997-2000.
Layoffs of that scale are politically unpalatable, particularly because it may be difficult to absorb the affected workers into the industries of China's new economy. Sizeable bankruptcies would also add to asset-quality issues at banks.
