Can the Chinese government afford bailing out its zombie state-owned companies

•  In the run up to China’s 19th Party Congress, one of the key questions for most analysts is what kind of solution will be taken to deal with China’s corporate debt problem. More specifically, given the sheer size of state ownership in China’s corporate world, the question really is whether state-owned enterprises (SOEs) will be restructured or bailed out.
•  This note aims at responding to a very specific question within the more general one of the path to be taken by China’s leadership regarding the future of state ownership in the prevision of goods and services. In particular, it estimates the fiscal cost of bringing financially unhealthy SOEs to a more sustainable situation. More specifically, we calculate the fiscal resources needed for zombie SOEs (i.e., those unable to pay their interest expense with their revenues) to a more comfortable level. To that end, we consider three scenarios:

1. The first incorporates central government funding to zombie so that they can cover their interest.
2. The second, more aggressive strategy, assumes that the fiscal injection allows zombie SOEs to reach the global industry average in term of financial health.
3. Given that, in the more expensive scenario, a large chunk of the funding will need to be injected to local SOEs (dominating the worst performing sectors, such as chemical, material and metals), we develop a third intermediate scenario, in which the central government supports central SASAC SOEs more than local ones.

•  While the scenarios above may look feasible, a number of clarifications are needed.
• These gloomy outlook should however be framed within China’s economic reality which facilitates the sharing of losses across other actors beyond the state. In particular, the government has been pushing for debt-to-equity swaps to reduce the burden of SOE’s cleaning up on the state and more should come in that direction.
• In a nutshell, it is hard to argue that there is not enough fiscal room to deal with SOEs financial malaise in the short run but that space could be much more limited down the road, especially if SOEs do not substantially increase their revenue stream on a sustainable basis.

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