EN 中文
首页 > 会议 > > Deleveraging and Role of Debt for Equity Swap
Home > Metting > > Deleveraging and Role of Debt for Equity Swap

Deleveraging and Role of Debt for Equity Swap

  • 简介:
  • Summary:
  • Deleveraging tops the agenda of China’s current priorities to “reduce leverage, overcapacity and inventory, lower cost and make up for weak spots”.

报 名Sign Up

议程

Deleveraging and Role of Debt for Equity Swap

YIN Jianfeng

 

National Institute for Finance & Development (NIFD)

University of International Business & Economics

 

I. SOEs Are Vital to Deleveraging

Deleveraging tops the agenda of China’s current priorities to “reduce leverage, overcapacity and inventory, lower cost and make up for weak spots”. However, as can be found through comparison with other countries, China’s leverage ratio is only at a medium level and far below the level of countries like Japan and Spain that are struggling with economic woes. For BRICS countries with leverage ratios below China’s, such as Brazil and Russia, their economies seem to underperform China’s. While excessive average is to be avoided, it is not the case that the lower leverage ratio, the better.

Further comparison of China, the U.S. and South Korea with similar leverage ratios reveals that despite the high leverage ratio in its non-financial corporate sector, China’s leverage ratios in household and government sectors are far below the levels of the U.S. and South Korea. Majority of liabilities in China’s non-financial corporate sector are SOE liabilities. After deleveraging for SOEs through debt for equity swap in 2000, the share of SOE liabilities in the non-financial sector kept on the decline but is so far still above 50%. After the deduction of household and government liabilities, however, SOEs account for more than 70% of liabilities in non-financial corporate sector. China’s rising leverage ratio after the hefty “four trillion yuan” stimulus package in 2009 is essentially an accumulation of SOE liabilities. That is to say, if deleveraging is China’s current top priority, the key to deleveraging is to reduce the leverage of SOEs.

Notably, the asset-liability ratio of SOEs indeed reached record highs. Since 2009, the aggregate asset-liability ratio of SOEs has been rising rapidly, reaching 67% in the first half of this year, which is above the level of 2000. Among all SOEs, central SOEs have been increasing leverage at a much faster pace. Compared with 2008, the asset-liability ratio of central SOEs rose by eight percentage points, reaching the record highs of 68%. Since 2011, the asset-liability ratio and indebtedness of central SOEs exceeded that of local SOEs: in the first half of this year, the liabilities of central and local SOEs amounted to RMB 45 trillion and RMB 38 trillion respectively.

II. Asset Side Is the Key to Deleveraging

For a company, if return on assets is higher than loan interest rate, shareholder interest will be best served by raising asset-liability rate. For an economy, if aggregate demand, capital deepening and economic growth can be spurred by investment with borrowed money, the supply side of the economy as a whole will also improve. In this case, leverage ratio for the economy should be increased.

However, the assets of SOEs are deteriorating. Return on SOE assets has been on the decline since 2008 and reached less than 1% in June 2016, the lowest ever since 1997 and far below the current benchmark one-year interest rate of 4.35% and even below the overnight lending rate of around 2%. In parallel to falling return on assets, SOE liabilities and assets kept on the increase, up over 15% in 2015.

With falling return on assets and stymied growth of primary operating revenue, SOE liabilities and asset expansion inevitably led to the “advancement of state sector and retreat of private sector.” At the onset of global financial crisis, the growth of household consumption, private enterprise investment and external demand fell sharply, while SOE investment compensated for aggregate demand, as reflected in the rapidly growing number of SOEs. According to the statistics of the Ministry of Finance, during 1997-2009, the number of central and local SOEs dropped from 250,000 to 110,000. After 2010, the number of SOEs began to increase. In 2014, it grew by 50,000 over 2010, reaching 160,000. Meanwhile, the overall efficiency of SOEs is significantly below the level of non-SOEs. Take industrial enterprises for instance, return on assets for large industrial enterprises averaged 7.7% during 2006-2014, while this figure only stood at 3.9% for SOEs. Although SOE expansion compensated for aggregate demand and stabilized the economy, the inefficiency of SOE assets compromised the supply-side efficiency of the economy as a whole.

In 2014, liabilities in seven sectors from industrial sector to wholesale, retail and catering sectors accounted for 96% of total SOE liabilities. Of which, government-affiliated organizations, social services, real estate, construction and transport and warehousing sectors experienced rising liabilities over 2008. SOE expansion since 2008 at least has the following problems: first, such an expansion is inconsistent with the long-term priorities of SOEs. According to the decisions adopted at the Third Plenary Session of the 18th CPC Central Committee, the “functions of various types of SOEs must be accurately defined”, so that state capital investment on public-interest enterprises will be increased and competitive sectors will be deregulated. Second, such an expansion is inefficient given the industrial structure. Return on assets is low or very low for the five sectors with rising shares of liability in 2008. On the contrary, the share of liabilities barely budged and even declined for strategic sectors with higher return on assets, including scientific research and technology services, IT services, education, culture and broadcasting.

III. Methods of Deleveraging and the Role of Debt for Equity Swap

Liabilities can be reduced either on liability side through debt for equity swap and eliminating zombie firms or on asset side through the improvement of corporate governance and introduction of new technology that contribute to higher return on assets. As mentioned before, enterprises must reduce leverage due to problems on asset side, so the solution must rest with asset side. Increasing return on corporate assets will contribute to TFP and potential growth rate and resolve the problem of long-term economic sustainability on supply side.

As can be learned from Japan’s lessons, deleveraging on liability side without addressing asset side will lead to stagnation without lowering the leverage ratio of economy. Hence, deleveraging on liability side must be combined with increasing return on assets. Such combination can be made through the following methods: first, optimizing the structure of enterprises and sectors with liabilities by increasing the liabilities of more profitable businesses and sectors and reducing those with little prospect of improving return. Here, let us focus on the issue of debt for equity swap.

Though it reduced the burden of SOEs, the debt for equity swap in 2000 did not fundamentally resolve the problem of inefficiency for SOE assets. As a matter of fact, improvement in SOE performance after debt for equity swap in 2000 largely benefited from China’s entry into the WTO in 2002 in a rising cycle of global economy. Now that 8 years have elapsed since the onset of global financial crisis, the world economy shows no sign of recovery from recession. In such a context, it is unrealistic to resolve the asset inefficiency and supply-side structural problems of enterprises by repeating the debt for equity swap in 2000.

We must have a correct understanding on what debt for equity swap is: (1) from liability side, debt for equity swap is indeed a means to supplement capital and reduce leverage; (2) from asset side, debt for equity swap is the fundamental means to improve shareholder and governance structures; (3) from an overall perspective, debt for equity swap is a means to define SOE functions and “give play to the decisive role of market and proper role of government.” In planning to conduct debt for equity swap, enterprises and government departments overlooked the second and third aspects.

    We must also have a clear idea about what debt for equity swap is not: (1) debt for equity swap is not a means to lower financing cost and burden for businesses. Equity should be held by economic entities other than banks and their subsidiaries. Otherwise, liabilities will still be in the same hands, though in another form. Nevertheless, return on equity is higher than return on liabilities; (2) debt for equity swap is not a means to enhance the capacity of banks to clear and recover liabilities. After debt for equity swap, banks will relinquish the right of mortgage and rank the last in the sequence of a company’s bankruptcy liquidation. Hence, banks cannot conduct debt for equity swap just to resolve the solvency difficulties of enterprises; (3) debt for equity swap is not a means to reduce overall leverage ratio. Instead, it should be targeted at sectors and enterprises with good technology prospects. These sectors and enterprises account for a limited share of SOE liabilities and as mentioned in the first point, if equity cannot be held by others market players, overall leverage ratio will not reduce after consolidation.

    In line with the spirit of the Third Plenary Session of the 18th CPC Central Committee for supply-side structural reforms, we must strive to improve corporate asset side and macroeconomic supply side through debt for equity swap while improving corporate financing structure on liability side. We must also improve China’s basic economic system encompassing property rights protection system, mixed ownership system, modern corporate system for SOEs and development of non-public economy.