In 2009, China launched a $600 billion stimulus program in an attempt to shield itself from the worst effects of the global financial crisis. Through its system of regional banks, the government offered cheap loans to thousands of state-run industrial enterprises, including steel, aluminum, cement and coal producers.
Massive infrastructure and real estate projects were undertaken, including new airports, power plants, roads and an expansion of the high-speed railway network. The investments not only saved millions of Chinese from the unemployment lines, but they also created millions of new jobs, which in turn pushed up domestic demand. These companies, however, created massive overcapacity in the Chinese economy and the dumping of cheap imports on the country’s biggest trading partners helped stoke tensions with the US and European Union.
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A decade on, many of the estimated 10,000 zombie companies — including more than 2,000 funded by the central government — are losing money hand over fist, partly as a result of their own massive excess capacity.
“These unprofitable firms only remain in operation because of government subsidies or further loans from state-owned banks,” Ludovic Subran, chief economist at the Paris-based credit insurance firm Euler Hermes, told DW.
Borrowing binge sours
Zombie firms have also helped fuel China’s massive debt crisis, which now threatens to derail the world’s second-largest economy. China’s total debt-to-GDP ratio hit 300 percent in 2018, with corporate and public at 160 percent of GDP last year, compared with 90 percent in 2008. Some economists think the country’s debt problem could drag down global economic growth, or even cause a new financial crisis, while others think China’s economy still has so far to grow that the huge debt burden will evaporate with inflation.
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Even so, China’s leaders have given themselves until next year to kill off the zombies and now face a delicate balancing act not to further weaken a slowing economy. More than 1,900 firms have already been disposed of, according to the head of the state assets regulator. In response, corporate bond defaults hit a new record last year, while banks’ nonperforming-loan ratio also reached a decade high.
“Closing them is easier said than done,” Max Zenglein, head of economics at the Mercator Institute for China Studies in Berlin, told DW. “They still have a role for securing jobs and are backed by vested interests.” Those interests include local government officials, financial institutions, their suppliers and other stakeholders.
The closure of so many zombie firms at once will also lead to defaults among their suppliers, a loss of taxes to local governments, and severe losses or even bankruptcy for regional banks. Zenglein said many of the firms being closed by provincial governments in Shaanxi, Henan, Hebei and Heilongjiang were “huge employers” whose demise will require “a wave of layoffs.”
“Rising unemployment is something that the government will be very concerned about as they are afraid of social unrest,” Zenglein said, adding that the blue-collar workers employed by these firms may struggle to find work in a labor market that has moved up the value chain.
A ‘second wind’?
Last year, China’s leaders had to quell sudden protests by property speculators in several cities when the price of their off-plan apartments dropped suddenly. Similar demonstrations erupted over the sudden collapse of thousands of online peer-to-peer (P2P) lenders, which saw tens of thousands of investors’ life savings wiped out.
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Many Chinese question why the government has waited until the economic downturn to take action against the zombies when unemployment is already rising and trade tensions with the United States continue. “The best time to clean up a zombie business is when the economy is better and the employment is more adequate,” the economist Tian Beiming wrote on Twitter in February, before complaining that many of the bankrupt firms were involved in corruption.
Subran said the clean up of the zombie firms should eventually give the economy a “second wind” and would help boost relations with the US and European Union, “who complain about excessive Chinese subsidies.” He said financial resources could then be shifted to more-productive sectors that will fuel domestic consumption, rather than exports, part of a major policy revamp by Beijing.
Although Subran thinks it will take longer than two years to unwind the thousands of zombie firms considering the current downturn, he believes that “pragmatism will prevail” and that China’s leaders will be able to contain the fallout. “The strategy will likely be gradual, with cutting overcapacity as the biggest priority,” he said.
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