source from：WSJ
ECONOMY  ASIA ECONOMY
IMF Warns China of Risks of Mounting Corporate Debt
Banks to hold more non-performing loans on their books as corporate profits decline

By MARK MAGNIER
June 10, 2016 10:45 p.m. ET
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BEIJING—Soaring corporate debt is a serious and worsening problem in China that needs to be tackled quickly if Beijing wants to avoid potential systemic risk to itself and the global economy, a senior International Monetary Fund official warned.


While China’s total debt of around 225% of gross domestic product isn't particularly high by global standards, its corporate debt at approximately 145% of GDP is high by any measure, the multilateral lending agency said.


“Mounting corporate debt is a key fault line in the Chinese economy,” David Lipton, the IMF’s First Deputy Managing Director, said in remarks prepared for delivery at a conference in the southern Chinese city of Shenzhen on Saturday. “Corporate debt remains a serious—and growing—problem that must be addressed immediately and with a commitment to serious reforms.”


The experiences of countries who saw a massive buildup in debt in the past underscore the need to act quickly and effectively to deal with both creditors and debtors, and to tackle governance problems in the corporate and banking sectors that led to the problem in the first place, Mr. Lipton said.


A defining characteristic of China’s situation is its state-owned enterprises, which by IMF calculations account for around 55% of corporate debt but only produce 22% of economic output. Last year, SOE profits fell 6.7% year on year while their total revenue fell 5.4%, according to Chinese government data.




In an environment of slowing economic growth—China’s economy grew 6.7% in the first quarter, its slowest pace since the global financial crisis—declining earnings and rising debt undermine the ability of companies to pay suppliers or service their debt, leaving banks holding more nonperforming loans, according to Mr. Lipton. China’s potential level of bad corporate-debt is at a “conservative estimate” equal to around 7% of GDP, the IMF said.


“The past year’s credit boom is just extending the problem,” Mr. Lipton said in a speech prepared for the China Economic Society Conference on Sustainable Development in China and the World. “Already many SOEs are essentially on life support.”


Debt-for-equity conversion may play a role in addressing the debt buildup, but banks need to be able to conduct triage and have the authority to distinguish between firms worth saving and those that should be allowed to fail, otherwise their equity will have no value, he said. Any use of public asset-management companies, meanwhile—a vehicle Beijing has used in the past—should involve their working down bad loans rather than simply warehousing them, he said. Mr. Lipton also questioned Beijing’s proposed idea of merging weak and stronger state companies, which he said doesn’t solve the problem but instead undermines the better company’s profitability.


China, which went through a debt crisis at the beginning of this century, could face a similar threat again less than two decades later. “If a country doesn’t address the governance issues at the heart of a debt problem, then that problem will inevitably recur,” Mr. Lipton said. “The lesson that China needs to internalize, if it is to avoid a repeating cycle of credit growth, indebtedness, and corporate restructuring, is to improve corporate governance,” he added.


That includes enhanced rule of law, transparent accounting systems, improved implementation and an end to subsidies that favor well-connected players, he added.