The Immense Challenges to Xi Jinping’s Supply-Side Economic Reform in China

By Li Modi, Epoch Times
June 26, 2016 7:44 pm Last Updated: July 2, 2016 5:07 pm

While central authorities have been preaching supply-side reform to save China’s limping economy, resistance and chaos prevails at provincial levels as local governments struggle to save their sources of revenue.

According to an article last month in the Chinese Communist Party’s authoritative newspaper, People’s Daily, the five major tasks surrounding economic reform—reducing overcapacity, destocking, deleveraging, reducing corporate costs, and shoring up weak growth areas—will all boost China’s development in the long term. Part leader Xi Jinping openly rebuked local government officials for not sticking to the plan.

The People’s Daily article on May 9, penned by an unnamed “authoritative figure,” named five provinces (Guangdong, Chongqing, Jiangsu, Zhejiang, Shanxi) for being on track in their supply-side structural reform programs. It also stressed that the supply-side reform may have short-term negative effects on GDP and fiscal revenues in “some” places, but if not carried out, there would be more “zombie enterprises,” and huge piles of debt would worsen fiscal and financial risks.

According to analysts, the “authoritative figure” represents the economic views from “the highest level.”

In addition to persuasive high-level statements, Xi repeatedly scolded local governments during provincial and ministerial level leadership meetings on their lacking economic management practices. On May 10, Xi told them to “avoid making the same mistake over and over,” and to “not be lured into various projects, investments, and financial activities just for the sake of money.”

During a meeting of the Leading Group for Financial and Economic Affairs on May 16, Xi remarked twice, “Some local governments are not fully engaged in supply-side reform. Some of their actions are not correct.”

Zombie Enterprises

China’s overcapacity has led to many “zombie enterprises,” in the steel, cement, coal, and other resource industries, as well as in the textile and garment industry. They are generally state-owned enterprises (SOEs) that consume public funds but don’t produce equivalent returns.

Zombie enterprises are on the verge of bankruptcy, but they just don’t close down. A main reason is that local governments won’t relinquish their personal interests and benefits in connection with these enterprises. Thus, the process of reducing overcapacity has created intense conflicts between the central and local governments.

While central authorities are demanding the reduction of overcapacity, local governments have their own interests. Reducing capacity has a very big impact on the local economy, finance, and employment, not even counting the benefits officials get from these enterprises. As such, chaos frequently ensues in local areas.

Zhao Xizi, a former honorary chairman of China National Association of Metal Material Trade, gave the following example of how officials keep zombie enterprises looking good on paper. He said a steel company’s statements showed profits of 2 billion yuan ($305 million). But an investigation revealed that the money was obtained from selling assets, which the company then declared as profits.

In another case, an unnamed leader of a large coal company stated that the company’s statements showed a profit of 50 million yuan ($7.6 million). But this was actually false. The company in fact had a loss of 1 billion yuan ($152 million).

For some local governments, they won’t even allow bankruptcies of SOEs to take place.

According to Chinese media, the chairman of the board of an SOE told the following story during a panel meeting of this year’s Chinese People’s Political Consultative Conference. An SOE subsidiary in China’s Southwestern region was prevented from filing bankruptcy after its business reorganization failed. Two years ago this company qualified for bankruptcy, but company representatives were blocked at the entrance of the courthouse with the explanation that the local government did not support the bankruptcy, hence the court could not accept the case.

Only after intervention by provincial-level authorities did the court eventually accept the bankruptcy case.  

Financial Games

An insider in the banking system indicated that a part of the bank loans has gone to SOEs and their subsidiaries, and many of them are zombie enterprises. Such companies readily get new loans to pay off old debts, and this accounts for a good portion of total bank loans.

Henan Daily recently published a report saying a number of financial measures were available to help the coal, steel, and other traditional industries in Henan Province. However, to obtain bank loans, enterprises that are having difficulties need to reportedly change their “main business type.” This indicates that they pretend to shift business into industries other than coal, steel, or any that has been in deep mire—a policy that is equivalent to encouraging enterprises to lie. If other provinces follow the Henan example, the efforts of reducing overcapacity may end up a failure.

In any case, a sense of chaos has followed orders to reduce overcapacity, with a huge amount of money moving about. Part of it has gone into the commodity futures market since April 11. Commodities from steel and cooking coal, to eggs, soybean, corn, and other agricultural products, became popular, leading to an abrupt rise in China’s futures market.

With tax revenue being the main pursuit of local governments, it has been every local government’s wish that steel companies elsewhere would fail except in their own local areas.

At the same time, authorities injected large amounts of credit into the overall economy this year, to the tune of over 1 trillion yuan (around $150 billion) each month since the start of the year.

Rising steel prices saved some dying steel mills, such as Wenshui Haiwei Steel in Shanxi Province. The company’s annual production capacity was about 300 million tons. It suspended production almost entirely in August 2015. According to a management staff member, the company now plans to resume production.

Shente Steel in Jiangsu Province is another company of similar size. The company shut down in December 2015, but with the surge in steel prices, it resumed production in March 2016.

According to Macquarie analyst Ian Roper, among China’s 50 million tons to 60 million tons of capacity that closed in 2015, more than 40 million tons of capacity have now resumed. “Given the rebound in prices and profit margins, reducing overcapacity is left behind.”

Oriental Daily Online commented that steel enterprises were large taxpayers. With tax revenue being the main pursuit of local governments, it has been every local government’s wish that steel companies elsewhere would fail except in their own local areas. This marks the conflict of interest pursuit between local governments and the central government.