Could Zombies Collapse China’s Economy?

No, not those zombies. ‘Zombie companies.’

Official numbers suggest that the Chinese banking system’s ratio of non-performing loans was unchanged at 0.9 percent in the second quarter.

However, the unusual amount of calm implied by the data masks the major risks that are forming in the Chinese economy.

In a report, BofA analyst Winnie Wu writes that “mismatching NPL pictures from top down and bottom up” are concealing a major risk to the Chinese economy – the proliferation of “zombie companies” being propped up by the China’s banking system. [...]

And those zombie companies are threatening the Chinese banking system

Banks are throwing good money after bad to prop up zombie companies because the government tells them to do so.

This is causing a deterioration in asset quality on banks’ balance sheets, and increases the chances that the government will have to bail them out down the road.

And that’s not the only risk zombie companies pose to banks.

As lending standards have tightened, companies have rushed to the corporate bond market to raise funds. According to BofA, corporate bond issuance has surged 70 percent from a year ago – and it’s not just healthy borrowers. Wu writes that “many LGFVs and troubled companies (eg LDK and Rongsheng) were able to issue bonds in the past 12mths, when bank lending was tightened.”

Unfortunately for the banks, this isn’t really a way to decrease the concentration of risk in China’s debt markets because the banks still underwrite more than 70 percent of all corporate bonds and outright own more than 50 percent of them.

In other words, Chinese banks face the same risks as bondholders as they do from lending.

It doesn’t take a genius to realize this is not a sturdy system for banks or the Chinese economy. The Chinese are an anvil on a pedestal of paper here.

If failing companies are not allowed to fail, it doesn’t help the economy – even in China. That’s what many conservatives and libertarians were pointing out during the bailouts and crises of 2008. Eventually, this all comes back to bite you again anyway. Thankfully the US doesn’t have such a  huge problem as China does in this instance, but you can bet if China takes a hit from this the rest of globe will feel it too.