China is rushing to set up rescue funds for government-indebted companies

Local governments in China are set to launch rescue funds worth billions of dollars to save state-owned groups after a flurry of high-yield defaults that have shaken international investors.

Public records have shown that six Chinese provinces have pledged at least Rmb110bn ($ 17bn) in funds since the end of last year, as cash crunch among the indebted state-owned enterprises affecting the local economy.

The wave of defaults included companies such as Yongcheng Coal and Electricity Holding Group, which plunged the local economy of Henan Central Province into crisis when missing an Rmb1bn debt payment last year and stopped paying some of its 180,000 workers.

“The whole province has suffered economically because only one SOE has failed to pay the payments in good time,” said an official in Henan, who started a rescue fund in April.

While China’s economy has been one of e first to recover since the Covid-19 pandemic, the rebound has been spewed in some provinces that are dependent on state industry.

Afflicted bonds issued by state-owned enterprises totaled Rmb119bn last year, the highest since China began allowing default SOEs in 2014, and from Rmb22bn in 2019. Defaults are worried investors, which had previously assumed the links will be supported by the state.

The rise in provincial bailout funds marked the latest effort by local Chinese authorities to restore creditors ’confidence. But analysts have warned that the strategy could backfire China’s debt development, which they have characterized as a time bomb for the world’s second largest economy.

“The purpose of the rescue funds is to send a message to the market that the government will intervene when things go wrong,” said Zhang Pan, head of research at Raman Capital, a Shanghai-based wealth manager. “They’re not going to make a poorly managed SOE a better managed business.”

While China endured an economic crisis in the 1990s, shutting down tens of thousands of losing state groups, Beijing is reluctant to do so again.

President Xi Jinping sees state-owned companies as the “bulwark of the economy,” in contrast to former Prime Minister Zhu Rongji, who in the 1990s took the approach of “keeping it big and let go of the little one ”to deal with SOE failures.

The heavily indebted northern province of Hebei was the first to establish a rescue vehicle, a SOmb Rmb30bn “credit guarantee fund” launched in September.

By the end of May, Jizhong Energy, a struggling state group in Hebei, had pulled Rmb15bn, or the equivalent of three-quarters of its revenue last year, from the provincial CGF to pay the principal of the bond and the interests.

“Our liquidity problem has eased a lot after the bailout,” said a Jizhong executive, adding that the group was very reluctant and would demand another Rmb15bn from the Hebei CGF in the coming months.

The funds take most of their funding from other companies controlled by local authorities. In Henan province, 26 SOEs ranging from coal mines to copper transformers have provided Rmb30bn of seed capital for a CGF.

“The provincial government wanted us to help when external financing is needed,” said a leader of Pingmei Shenma Group, an energy conglomerate and shareholder of Henan CGF.

Following the Yongcheng coal deficit, the issuance of bank loans fell by 10 percent in Henan in the first half of the year, compared with a growth of 6 percent nationwide.

Meanwhile, official data showed net financing of the province’s corporate loans – new issuance of lower interest loans plus principal payments on existing loans – was less than Rmb20.1 billion in the first six months of the year. This compared to Rmb71bn a year earlier.

The credit crunch in Henan has convinced Beijing to start pressuring local authorities to help SOEs in need. As a result, only one has defaulted on bonus payments this year. But investors have been concerned about the lack of reform among afflicted SOEs.

“The government does not have a long-term plan to turn bad SOEs into good ones,” said a counselor to the Hebei Heritage Supervision and Administration Commission, the SOE regulator. “Their priority is only to overcome the short-term liquidity crisis.”

State-owned banks, the largest credit providers, are also cautious.

“Rescue funds are too small to meet the demand for funding from a large amount of moneyless SOE,” said a risk management official at one of the country’s leading financiers. “We need to prioritize benefits over local interests.”

In Hebei, an executive of one of the local CGF shareholders said the company has decided to pay into the rescue fund because of political considerations, rather than business.

“We do not expect a market return from the investment,” the official said.

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