China’s state-owned enterprises employ tens of thousands of workers in areas such as coal mining or steel production © EPA

Local governments in China are racing to launch rescue funds worth billions of dollars to bail out state-owned groups after a flurry of high-profile bond defaults that shook international investors.

Public records showed that six Chinese provinces have committed at least Rmb110bn ($17bn) to the funds since the end of last year, as a cash crunch among indebted state-owned enterprises hit local economies.

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

“The entire province has suffered economically because a single SOE failed to make bond payments on time,” said an official in Henan, which started a bailout fund in April.

While China’s economy has been one of the first to recover from the Covid-19 pandemic, the rebound has been patchy in some provinces that are dependent on state-owned industries.

Distressed bonds issued by state-owned enterprises totalled Rmb119bn last year, the highest since China started allowing SOEs to default in 2014, and up from Rmb22bn in 2019. The defaults have worried investors, who previously had assumed the bonds would be backed by the state.

Line chart of Median yield (%) on state-run enterprise bonds in... showing Chinese SOE finances unsettle investors despite lack of defaults

The rise of the provincial bailout funds marked local Chinese authorities’ latest effort to restore creditor confidence. But analysts warned that the strategy could instead worsen China’s debt overhang, which they characterised as a time-bomb for the world’s second-largest economy.

“The purpose of bailout funds is to send a message to the market that the government will step in when things go wrong,” said Zhang Pan, head of research at Raman Capital, a Shanghai-based asset manager. “They are not going to make a mismanaged SOE a better-run business.”

While China weathered an economic downturn in the 1990s by closing down tens of thousands of lossmaking state groups, Beijing is reluctant to do so again. 

President Xi Jinping sees state companies as the “bulwark of the economy”, in contrast to former premier Zhu Rongji, who in the 1990s took the approach of “keeping the big and letting go of the small” to deal with SOE failures.

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

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

“Our liquidity problem has greatly eased following the bailout,” said an executive at Jizhong, adding that the group remained highly leveraged and would apply for another Rmb15bn from the Hebei CGF in the coming months. 

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

“The provincial government wanted us to help each other when external funding dries up,” said an executive at Pingmei Shenma Group, an energy conglomerate and shareholder of the Henan CGF. 

In the wake of the Yongcheng Coal default, bank loan issuance fell 10 per cent in Henan in the first half of the year, compared with growth of 6 per cent nationally. 

In the meantime, official data showed the province’s net corporate bond financing — new bond issuance minus interest plus principal payments on existing bonds — was minus Rmb20.1bn in the first six months of the year. That compared with Rmb71bn a year earlier.

The credit crunch in Henan convinced Beijing to begin pressuring local authorities to help distressed SOEs. As a result, only one has defaulted on bond payments this year. But investors remained concerned about the lack reform among distressed SOEs.

“The government doesn’t have a long-term plan to turn bad SOEs into good ones,” said an adviser to Hebei’s State-owned Assets Supervision and Administration Commission, the SOE regulator. “Its priority is just to get through the short-run liquidity crisis.”

State banks, the biggest suppliers of credit, are also cautious.

“Bailout funds are too small to meet the funding demand from a great many cash-strapped SOEs,” said a risk management official at one of the country’s top lenders. “We need to prioritise performance instead of local interests.”

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

“We don’t expect a market return from the investment,” said the official.

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