The biggest uncertainty from China's industrial restructuring is what will happen to bad debts

Photo by Guang Niu/Getty Images

Earlier this year, China’s state council issued guidelines on cutting overcapacity within the nation’s vast steel and coal sectors over the next three to five years, pledging to reduced steel capacity by around 10-15%, with coal by an even larger 20%.

The declines, representing around 100-150 million and 500 million tonnes of capacity respectively, will have ramifications for many Chinese workers in both industries. According to China’s Ministry of Human Resources, 1.3 million steel workers will lose their jobs, with a further 500,000 positions in the coal sector also set to go.

They’re massive numbers, even for a workforce the size of China’s.

According to Qu Hongbin and Julia Wang, part of HSBC’s China economic team, the figures offered by the government could be close to doubled in actuality, suggesting that 3.5 million workers could lose their jobs as a result of the announced capacity reductions.

The table below, supplied by HSBC, shows total employment in large Chinese industrial firms. Based on HSBC’s estimates, 17.436 million people – including those at smaller firms – were employed in these sectors as at the end of 2015.

“We have made two slightly more aggressive assumptions,” says HSBC. “Firstly we had assumed 20% capacity reduction, instead of 10-15%. Secondly, we had included the whole non-ferrous metal sector (instead of just the aluminium sectors).”

Based on its assessment, unemployment that could increase by around 3.5 million as a result of the overcapacity curbs would equate to around 0.9% of total urban employment in China.

Big figures, and expensive from a fiscal perspective.

“Extending the government’s assumption for RMB55,000 per worker, this puts the overall fiscal cost at RMB200bn,” says HSBC. “Although this is a sizable commitment, it is feasible in the context of large fiscal revenue which exceeded RMB15trn in 2015.”

While from an employment and fiscal perspective HSBC believes that the task for the government is manageable, whether that will extend to China financial system, amidst a likely increase in bad debt levels, remains perhaps the biggest uncertainty.

HSBC explain:

One of the other key outstanding questions is how quickly will banks recognize the bad debt that come as a result of these restructuring. Although details are yet scant, media has reported that China plans to allow some banks to swap corporate debt into equities in the underlying companies in select cases. At the time of writing there is still significant uncertainties over how exactly this scheme would work. During the last major banking sector restructuring in the late 90s, China had allowed banks to sell their bad debt to asset management companies, and recapitalised the banks via fiscal injections. It is unclear therefore whether the recent plan would again involve such asset management companies, as well as how valuation and ownership would work.

Though there are clear uncertainties as to how this mammoth industrial restructure will play out, including the potential for social unrest, HSBC suggests that a number of factors will likely come together to stabilise economic growth in the year ahead.

“It is becoming increasingly clear that policy makers are taking a more proactive approach to deal with the various aspects of the restructuring process,” says HSBC. “The combination of faster supply side adjustment, as well as more monetary easing, fiscal expansion should increase the chance of growth stabilisation in the coming year.”

If HSBC is proven right, it’d be a remarkable achievement for the Chinese government given the scale of the task at hand.

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