Rising debt levels in China and recent policy pronouncements suggest an approaching collision of economic policy goals.
Regulators have been gradually moving toward banking reforms since last March when People's Bank of China (PBOC) Governor Zhou Xiaochuan announced that China would likely lift its controls on deposit rates in one or two years.
The pledge was made under pressure from competition with China's growing but unregulated "shadow banking" sector and online financial products that offer higher-yielding but higher-risk returns.
At the time, a survey by China Youth Daily found that nearly 85 percent of depositors had invested in Internet "wealth management products" that earn more than accounts in state banks.
The outlook was complicated in November when the PBOC cut interest rates in an effort to spur the economy, dropping lending rates by 0.40 percent point while lowering the deposit rate by a smaller 0.25 percent.
On March 1, the PBOC cut the benchmark loan and deposit rates again, both by 0.25 percent point, hoping to halt the slide in growth.
But in a complicated move, the regulators sought to liberalize deposit rates at the same time by allowing banks to offer premiums over the official ceiling, first by 120 percent of the benchmark and then by 130 percent.
The result was that one-year deposit rates were left essentially unchanged.
Impact on SOEs
Analysts warned of a squeeze on bank margins in the near term, but some economists have raised concerns about longer-range impacts of interest rate reforms on China's heavily-indebted state-owned enterprises (SOEs).
The thinking is that the gradual lifting of PBOC controls will eventually lead to increased returns on bank deposits, which will still be competing with higher-paying Internet instruments.
When banks then raise lending rates, financial burdens will rise on SOEs, which are already under a mountain of 67.1 trillion yuan (U.S. $10.7 trillion) of debt, according to Ministry of Finance figures for 2013.
The returns on assets in the bloated SOE sector are only one-third of those for private companies and half of those for foreign enterprises, said Ryan Rutkowski, a former research analyst at the Peterson Institute for International Economics in Washington, in a recent posting.
"More importantly, as China continues the process of reforming the financial sector and eventually removes deposit interest rate controls, the resulting higher lending rates will likely put additional pressure on less profitable firms," Rutkowski wrote.
Increases in lending rates will raise default risks among SOEs, he argued.
Returns for China's 155,000 SOEs were only about half the weighted average bank lending rate of 7.33 percent in the third quarter last year, he said.
For 2013, the finance ministry reported net profits of 1.9 trillion yuan (U.S. $304 billion) and total assets of 104.1 trillion yuan ($16.6 trillion), the official Xinhua news agency said.
Figures for 2014 appear inconsistent, because the ministry reported a 12.1-percent rise in assets, although the estimate of 102.1 trillion yuan was lower. A similar increase was cited for "liabilities" of 66.5 trillion yuan, which was less than the 2013 debt estimate.
Interest rate liberalization
In light of the government's concerns about declines in economic growth, the PBOC could probably declare interest rate liberalization now without much risk that rates would increase.
“Lending rates are unlikely to rise given other measures and market conditions,” said Yukon Huang, a senior associate at the Carnegie Endowment for International Peace and a former World Bank country director for China, in an email message.
In a sign of economic weakening last month, China Everbright Bank became the first listed lender to drop its one-year deposit rate below the 3.3-percent effective ceiling, offering 3.16 percent, Bloomberg News reported on Feb. 10.
“Pressure on attracting deposits is coming off recently with a slew of easing measures—at the same time, with the economy doing so badly, banks are finding it hard to lend that money out,” said Tang Yayun, an analyst at Northeast Securities Co. in Shanghai.
But Rutkowski makes the case that if a rise in lending rates does follow liberalization, it would add pressure on SOEs along with existing government policies to curb debt growth, driving further efforts to partially privatize SOEs.
Under a Communist Party of China (CPC) Central Committee policy announced in November 2013, the government has been pursuing a “mixed ownership economy, allowing more SOEs and other firms to develop into mixed-ownership companies.”
The policy, which falls short of outright privatization, aims to draw private investment into the state sector and reform management practices at stagnant SOEs.
In his work report to China's annual legislative sessions last week, Premier Li Keqiang promised to "implement the reform of introducing mixed ownership to SOEs," but progress has been slow so far.
Early experiments with mixed ownership have left it unclear how far it will go.
Sinopec as a model
The scheme for leading state-owned refiner Sinopec has been promoted as a model.
Under the plan announced last year, Sinopec sold a nearly 30-percent share in its retail business valued at 107.1 billion yuan (U.S. $17.1 billion) to 25 investors and funds.
Eleven were identified as domestic private investors, accounting for 35.8 percent of the total, the official English-language China Daily reported last September.
Last week, Xinhua reported that one of the investors had not fully paid for a planned share "due to a lack of sufficient capital."
The partial privatization approach has met with mixed reviews.
In an earlier interview, Yukon Huang said the mixed ownership model is "unlikely to work."
"Essentially, it doesn't change the control structure," he said.
Rutkowski believes that even partial privatization will be "a challenge," since the state is unlikely to ease its grip on the most valuable assets in strategic sectors, including energy, railways, post and telecommunications.
Other sectors like real estate and construction may not fetch full value due to waning economic growth, he said.
The situation may leave social services and consumer segments as the most opportune for privatization efforts.
Rutkowski estimates that full divestiture in these areas would bring in 14 trillion yuan (U.S. $2.2 trillion), making a dent in SOE debt.
For now, the PBOC interest rate cuts seem aimed at easing financial burdens on big industrial enterprises, which are major borrowers, but if future liberalization leads to market-driven rate hikes, the pressures for more extensive privatization could rise on SOEs.
In the 80s, I've worked in industries and factories as a visiting service engineer, according to my observation, much efforts were done in the modernization and updating of technologies and imports of foreign know-how, the Chinese have tried hard despite natural catastrophes and much unwanted corruptions... . A lot of leakage of monetary investments took place, but I still have hope that eventually after appropriate and effective rectifications have been made, China will continue to strive and flourish!
May 08, 2015 12:26 PM
The CEOs of China's SOEs are selected by the Communist Party's Organization Department according to political criteria, not by a corporate board of directors according to economic criteria. It is thus extremely risky to invest in such Party-controlled state enterprises.
Mar 13, 2015 04:48 PM
