The Chinese government is bandying about debt for equity swaps as a potential cure for the overhang of corporate debt in the middle kingdom. Much, if not most, of the bank loans in China have been made by government owned banks to state owned enterprises (SOEs). This is a game of three card monte. Between the government, the SOEs and the banks, it’s just a matter of deciding where the losses are concealed.
According to the Caixin article, when last done in 2004, special purpose asset managment companies took the debt off the hands of the banks at face value. No writedowns, no restructurings of underperforming companies, just a shell game. Eventually the government absorbed the losses from the asset management companies. With 10% real growth and higher nominal growth that worked very well. High Chinese growth rates in the century’s first decade more than doubled GDP, minimizing the size of the hit Beijing took on the bad debts.
This time is different. High nominal growth will not bail out China. The debt is too large and growth has slowed. Caixin is advocating that this be used as an opportunity to let market players restructure the SOEs into efficient firms using techniques drawn from the private equity and distressed investment playbooks. Of course the market players they point to are government controlled. This is a policy choice, not a private sector solution.
Will Beijing repeat the past by keeping companies alive via cheap loans, taking the hit on their balance sheet for bad debt and screwing savers through low rates? Or will they take the restructuring path suggested by this trial balloon? Are they willing to take the credit policy lever and turn it, through debt for equity swaps, into a restructuring mechanism? It will take cast iron will, because, if they do this, many will lose their jobs.
Whether or not they are willing to make this choice will help decide whether or not China differentiates itself from Japan in how it handles its economic transition. This has the potential to get China moving in the right direction. Keep an eye on it.