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‘Zombie companies’ adjust to new reality

Du Juan
Updated: Mar 15,2016 7:41 AM     China Daily

[Photo by Guo Xizhong/China Daily]

After a career spent building and repairing ships, Bao Hongyi (a pseudonym) never expected the shipping industry to sink so fast.

A month ago, the State-owned Wuzhou Shipyard, where 48-year-old Bao began work as a technician in 2001, filed for bankruptcy.

“I used to think that day would never come to a State-owned company,” said Bao as he sadly surveyed the shipyard on Wukuishan Island, in Zhoushan city within East China’s Zhejiang province.

Wuzhou Shipyard is one of the scores of so-called “zombie companies” that are economically inviable and which China has decided to phase out.

Pulling the plug on such enterprises became a priority when Premier Li Keqiang delivered the government work report on March 5 and explained why it is no longer in China’s interests to subsidize poor performers.

Zombie companies are economically inviable businesses, often in industries that have severe overcapacity, and have been kept alive long after they should have died thanks to money poured in by governments and banks.

Local authorities and financial institutions typically propped up such industries to protect local economies and jobs.

In addition to the shipbuilding sector where Bao worked, other industries undergoing massive change include steel, coal and cement, where there have been heavy financial losses in recent years because of huge overcapacity.

China’s producer price index, a weighted listing of prices measured at the wholesale or producer level, fell for 47 months, largely because of the unsustainable situation.

Bao said things at Wuzhou Shipyard started to go sour during the global financial crisis of 2008.

“At its peak, in around 2007, there were so many-more than 3,000-employees working here that there were not enough dormitories to house them all,” recalled Bao.

But shipbuilding started its downward spiral when shipping rates fell during the global recession. A 64,000-metric-ton bulk carrier that would have once sold for 320 million yuan ($48 million) now has a price tag of 120 million yuan.

With shipbuilding facing such pressure, by the end of September, Wuzhou Shipyard had amassed debts of 911 million yuan against total assets of 534 million yuan.

It cut jobs, but there were still enough orders and money coming in from its parent company, the State-owned Zhejiang Shipping, to keep things limping on for a few months. In the end, though, despite still having some orders on the books, it was just too expensive to keep the factory gates open.

“The original plan was to shut down production after completing unfinished ships, which would have helped pay off some debts,” said Han Jun, a lawyer and trustee in the shipyard’s bankruptcy. “But the shipping industry just didn’t recover, and we were worried the ships would never be sold.”

Zhejiang Shipping eventually cut Wuzhou Shipyard loose-partly because it was a drain on finances, but also because the central authorities in Beijing had decided that it was time to be tough on such zombie companies.

Government officials noted that the vast sums of money flowing into zombie companies could be better spent funding innovators and other businesses with a promising future and on retraining and reemploying workers.

In South China’s Guangdong province, the country’s manufacturing powerhouse, authorities announced they would close all zombie companies within three years. The local government and other agencies there are working flat out trying to help the new hoards of jobless.

Another industry facing up to reducing production or going bankrupt is iron ore mining, which has been hit hard by cheap imports and shrinking demand ever since 2012, when the economy slowed.

“Domestic iron ore mines have much higher production costs compared to the world’s top mining giants, which have been pouring their products into China’s steel mills,” said Du Cheng, an analyst at JYD Online Corp, a Beijing-based bulk commodity consultancy company.

He said a large number of iron ore mines in Hebei and Shandong provinces had slashed production during the past year.

“A large-scale mine in Anhui province produced 2.22 million tons of iron ore in 2015,” Du said. “That company lost 120 yuan, on average, for every ton of production, which means it was more economical to cut down on production.”

But Du said slashing production would have meant massive job losses and the local economy was not yet ready for so much pain.

“So, instead of cutting output, its production target rose to 2.65 million tons for 2016,” Du said. “Some big mines with huge losses are helping their miners to work in other sectors, such as their logistics units within the company. It’s a long process with practical difficulties.”

The government’s commitment to address overcapacity chimes with its economic reform agenda, through which the nation plans to shift to supply-side structural reform, something Beijing has put high on its agenda.

The government will establish a fund of 100 billion yuan to assist those made redundant as a result of industrial restructuring, according to the Ministry of Industry and Information Technology.

When Wuzhou Shipyard went bankrupt, the parent company paid out in full its obligations to employees who had lost their jobs. Regional governments are preparing to meet similar obligations.

Chen Naike, a deputy to the National People’s Congress, the nation’s top legislature, said it is vital that workers losing their jobs get subsidies and help in adjusting.

Li Xinchuang, head of the China Metallurgical Industry Planning and Research Institute, said the central government plans to cut the nation’s production of crude steel by between 100 million tons and 150 million tons in the next five years.

Li said that means 500,000 employees in the steel industry will have to find new work.

“Currently, there are more than 300,000 employees in zombie companies in the labor-intensive steel industry,” Li said. “It will be a priority for the government to deal with those people effectively.”

He said China’s steel companies’ debt ratios average around 70 percent while in some cases it is even higher.

“For instance, a steel company, which has already stopped production, had a total debt of more than 10 billion yuan and its assets were only worth 6 billion yuan,” said Li. “Another steel company has a severe wage arrears problem of more than 360 million yuan. Such big debt issues are hard for the local government or a single company to solve.”

In addition to the government’s determination to reform inefficient and unsustainable industries, financial institutions are also playing their part in killing off zombie companies.

They have been asked not to lend money to steel, coal and nonferrous metals companies that have been blacklisted because of their overcapacity.

Meanwhile, financial institutions are doing their best to protect companies’ assets by preventing zombie companies from transferring funds illegally.

The government says it wants to see financial reserves, land and human resources flow toward other promising industries when zombie companies close.

And Bao said many of his former colleagues are already moving on and have been finding other work.

“A young technician I worked with found a job with a cruise company,” Bao said. “Opportunities are emerging in new industries like this.”