Recently, we have been hearing a lot of stories on the Chinese government’s hope to encourage private investment, particularly into industries that were previously restricted or monopolised by state-owned enterprises. For instance:
All these, as we understand, are parts of the game plan to bolster economic growth. According to Reuters:
China will open up its public utilities to private investment as part of the current privatisation drive to bolster economic growth
While this WSJ says:
Chinese authorities have already announced a number of initiatives to bring private capital into areas of the economy that have been traditionally dominated by the state, partly to help boost economic growth.
All these talks about encouraging private capital baffle us not so much because it is “wrong”. In fact, one could always argue that the Chinese government has too much control over the economy through state-owned enterprises (state-owned banks in particular), and very few as far as we understand would argue that the state allocate capital better than the free market in the long run. We believe that the obsession of economic growth regardless of return on capital will destroy corporate profits in the long-run.
So what is so baffling here?
The problem is that all these are not going to help growth, at least in the short-run.
China’s private sector could very well be deleveraging at this very moment. With overcapacity across the economy, an attempt to reduce the role of the state within the economy will not increase the involvement of the private sector.
This is very well illustrated by the mini-credit crunch in Zhejiang we mentioned earlier. As private companies often require third-party guarantees to obtain loans from banks, many of the private sector enterprises ended up guaranteeing loans for each other. That was all going well until when one company went bust. Fearing that the loans will go bad as the guarantor went bust, banks called loans from other companies that were guaranteed by the one company that went bust. Because of the complex network of mutual guarantees, more than 600 hundred companies were dragged into liquidity crisis after that one single company went bust. Not to mention the crisis surrounding Zhongjiang, yet another company which has gone bust. This is forced deleveraging at its worst.
So what do these companies do to save themselves?
They wrote to the government and asked for a bail out.
Yesterday, 21st Central Business Herald reported that Zhejiang provincial government confirmed that they have received a letter from 600 companies in Hangzhou area hoping for assistance from the government. These companies are hoping that government can help clean up the mess, and hoping that the government can persuade banks to stop calling loans.
In another news, Jiangxi provincial government has decided to backstop the biggest private enterprise in Jiangxi: LDK Solar, according to Yicai. LDK Solar was the first company from Jiangxi to have listed in the New York Stock Exchange. As the company’s profitability fell over the years, it was taking on ever larger debt. Total liabilities of the company reached RMB30.230 billion by the end of 2011, while loss amounted to RMB5.49 billion for 2011. In the first quarter this year, gross profit margin turned negative for the first time. The company is considered to be too big to fail by the local government, apparently, thus the provincial government shockingly decided to backstop the company, effectively helping the company to service its debt with local government’s revenue.
The on-going economic slowdown and highly over-stretched balance sheets of private corporate sector are forcing companies to deleverage. This is definitely negative as far as economic growth is concerned. Although no one would deny that greater private sector involvement is the right direction for China in a long run, this is not going to happen in such environment, whether the Chinese government like it or not, and private sector is no saviour as far as short-term economic growth is concerned.
This article originally appeared here: Private sector is not the saviour of the Chinese economy
Also sprach Analyst – World & China Economy, Global Finance, Real Estate
Read more posts on Also Sprach Analyst »
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.