By Merisha Enoe and Anders Hove
The reform of China’s state owned enterprises (SOEs) is a crucial factor not only in stimulating competition and future economic growth, but also for the country’s effort to battle air pollution. We believe that real, market-driven competition would help develop a vibrant renewable energy sector and also reduce economic distortions that favor energy-intensive, heavy manufacturing industry. And so when the state-owned Baoding Tianwei, which was at once a sprawling, heavy industrial conglomerate and a renewable energy manufacturer, announced last week that it would not make an RMB 85.5 million (US$ 14 million) bond interest payment, market reformers and environment experts alike were encouraged: It looked like the company was going to be the first SOE allowed by the Chinese government to default. It looked like a sign of progress, both in the development of a mature bond market and as a step toward reform of China’s state-owned enterprises (SOEs) and state-dominated financial system.
It may seem odd to be heralding the possible default of a company that is heavily invested in solar energy. But market-driven competition among renewable energy manufacturers is hugely important, because it would strengthen the entire renewables sector. At present, thanks to the fact that the government continues to prop up many inefficient and economically unviable state-owned renewable companies, there is an overcapacity of upstream renewable energy manufacturing. Distressed solar panel manufacturers LDK and Suntech, for example, have reorganized without merging with their stronger peers. Consolidation could help reduce manufacturing costs and investment uncertainty, strengthening remaining players in the short-term and making renewable energy more competitive as an energy source in the long run. And so the reported default of Baoding Tianwei, though bad news on the face of it, seemed like a step forward for the market.
But last week state-owned China Construction Bank (CCB) announced that it would pay the firm’s bond interest. (CCB owns much of the company’s debt in any case.) This suggests that the implicit state guarantee for SOE debt remains in place for now, reducing risk for lending to such entities and acting as a financial subsidy for the whole sector. SOEs dominate China’s energy and heavy manufacturing sector, and the cheap financing available to such firms helps them maintain or expand manufacturing or energy-production facilities in areas where the government is seeking to reduce excess capacity, like steel, cement, solar and coal. At the macro level, cheap financing for manufacturing also reduces funding for small companies and the service sector.
SOE reform is high on China’s policy agenda. The CCB announcement came the same week as reports that China would reduce the number of national SOEs to just 40, both to encourage consolidation and increase the role of markets. And so it’s unclear how the Baoding Tianwei default ultimately will be handled.
The bottom line: Market forces can play a larger role in accelerating China’s transition towards a cleaner economy, but stronger signals are needed from the government to accelerate change. The Baoding Tianwei case may be a step in the wrong direction.
Anders Hove is Associate Director for China Research at the Paulson Institute. Merisha Enoe is Manager of Research at the Paulson Institute.