China’s Economic Mystery: The Astonishing Survival of Troubled Firms
China’s economy is a puzzle wrapped in an enigma. On one hand, it boasts an unusually low number of companies going bankrupt, especially when compared to the United States. But on the other hand, many Chinese companies are drowning in financial troubles.
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The Unseen Challenge
Beneath the surface, China faces a growing crisis of corporate defaults. This is especially true for property developers. In 2020, half of the 50 largest property developers were in deep financial trouble. They struggled to restructure their debts, couldn’t easily borrow new money, and had a tough time repaying existing loans. The fear of a massive financial crisis motivates policymakers, banks, and businesses to keep these companies afloat. However, this approach stifles economic growth and worsens the overall economic situation.
China’s Unique Approach
China’s way of preserving struggling businesses is quite different from Western practices. Local government officials pressure banks to support even the least productive companies. Strict lending rules make it challenging for companies to get rid of their debts, and state-owned banks, ultimately accountable to the government, are hesitant to face significant losses. To declare a company, bankrupt in China, it requires agreement from multiple parties, including courts, creditors, local governments, and regulators.
The Cycle of Refinancing
Research shows that in some regions of China, where they have special courts for bankruptcies that operate independently from local authorities, more new companies are being created, better productivity, and lower borrowing costs. In other regions, creditors ask for more interest because they know getting their money back is tricky.
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Long Legal Processes and More Liquidations
The rules that are meant to keep weak companies alive sometimes lead to more liquidations when cases finally reach the courts. A staggering 83% of companies in Chinese bankruptcy courts end up closing, compared to just 5% in the United States. These legal proceedings in China also take much longer, around 50% longer than in the United States.
Global Impact
China’s way of dealing with bankrupt companies has an impact beyond its borders. China is a major lender to governments worldwide, but its strict approach to debt forgiveness has made international discussions about debt much harder. We saw this in a case involving Sri Lanka’s debt and the International Monetary Fund (IMF). China’s unwillingness to accept debt write-offs caused problems.
Takeaway: China’s economic performance is a tightrope walk, characterised by an extraordinary mystery. While the nation’s low corporate bankruptcy rate appears reassuring, the underlying challenges of corporate defaults, barriers to creative destruction, and a cycle of refinancing paint a more intricate picture. As China grapples with preserving troubled companies while averting a financial catastrophe.
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