Conditions in China’s corporate sector

Abstract

Revenue and profit growth have slowed in China’s corporate sector in recent years, alongside a broader moderation in China’s economic momentum. The slowdown has been most severe for labour-intensive private companies, particularly export-oriented manufacturing firms. The government has responded by announcing a range of measures aimed at easing financial conditions faced by the private sector. Earlier efforts by the Chinese authorities to reduce risks in China’s financial system appear to have been successful in stabilising leverage in the state-owned sector, but the financial position of private sector firms is more fragile, and risks remain elevated in the real estate industry. Introduction Conditions in China’s corporate sector are important for Chinese economic growth and financial stability, and have significant implications for China’s major trading partners, including Australia. Chinese business investment has been an important source of economic growth, and driven demand for resource commodities. However, by the same token, the corporate sector has been the largest contributor to non-financial sector leverage, and corporate debt remains very high by international standards. Analysis of the activities and financial health of China’s companies is also helpful for forming assessments about the broader trajectory of the Chinese economy and the effectiveness of government policies affecting businesses. A range of previous studies has examined conditions in China’s corporate sector.[1] These analyses have documented the decline in corporate profitability and rise in leverage since 2008–09, which stemmed from the rapid increase in debtfunded investment that formed part of the Chinese Government’s stimulus response to the Global Financial Crisis (GFC). This article provides an update on recent developments by drawing upon official industrial survey data. However, the official survey data only cover a limited number of industries and are restricted to B U L L E T I N – D E C E M B E R 2 0 1 9 7 1 companies above a certain size.[2] Therefore, for more detailed sector-level analysis, this article uses alternative data derived from the financial statements of listed companies. As at the end of 2018, more than 3,300 non-financial companies were listed on the Shanghai and Shenzhen stock exchanges, with a combined value of CNY58 trillion in assets.[3] Listed companies represent a relatively small but growing share of China’s broader corporate sector: these firms accounted for around 10 per cent of non-financial enterprise assets in 2016 and around 10 per cent of non-financial corporate debt in 2018. Revenue and Profit Growth Has Weakened, Driven by the Private Sector A range of indicators suggests that growth in revenue and profits of Chinese firms has slowed noticeably in the past few years. The profitability of industrial firms captured in the official industrial survey had been trending lower following the 2008–09 stimulus. In large part, this downward trend reflected the fact that returns to new large capital outlays declined following the extremely large boost to investment that occurred during the period of stimulus. Profitability rebounded in 2016 and 2017 following government efforts to reduce overcapacity, leverage and the cost of doing business, under the policy framework of ‘Supplyside Structural Reform’ (see Boulter 2018). However, in the past two years, growth in revenue and profits has moderated again, and the return on equity has trended sharply lower (Graph 1). A similar pattern has been apparent for listed companies (Graph 2). The recent slowdown in operating revenue and profit growth reported by both listed and unlisted companies suggests that, in aggregate, supply-side policies were only temporarily able to limit the downward pressure on business profits. Moreover, the slowdown appears to have been exacerbated by efforts by Chinese regulators to reduce risks in the financial system; these efforts have resulted in a squeeze on lessregulated sources of credit, which private firms are more reliant on. The deterioration in profitability is also likely to be related to a broader slowdown in global manufacturing and trade that has weakened the cash flow of export-oriented firms. The more granular ownership and industry-level data reported by listed companies allow us to analyse the drivers of the slowing in corporate sector profitability in more detail. The data suggest that the slowing since 2017 has been driven by private companies (Graph 3).[4] By contrast, the profitability of state-owned enterprises (SOEs) has been trending higher. It is likely that the profitability of SOEs has continued to be supported by the government’s implementation of supply-side policies, since the high leverage and excess capacity characterising these firms made them the primary target of these policies. SOEs have responded by reducing their investment expenditure and have reduced excess capacity, particularly in the mining Graph 1 China – Industrial Sector Financial Indicators* Seasonally adjusted Year-ended growth 2014 2009 2019 -50 0 50 100 % Revenue Profit Return on equity 2014 2009 2019 12 15 18 21 % * December observations removed. Sources: CEIC Data; RBA Graph 2 China – Listed Company Financial Indicators Year-ended growth* 2014 2009 2019 -120 0 120 %