China’s campaign to slim down its bloated industries could be derailed by more than $1.5 trillion of debt in its steel, coal, cement and non-ferrous metal sectors, which threatens to overwhelm local banks.

Tackling industrial overcapacity has become a priority for Beijing to make its slowing economy more efficient and address a supply glut that has hammered coal and steel prices.

China is providing more than 100 billion yuan ($15 billion) in the next two years to handle layoffs from coal and steel, but that will only be made available once debts have been settled.

That’s the key detail in the plan. Critics say there is no clear mechanism for tackling the debt burden, which will put huge strain on the weakest sections of the banking sector.

“China needs to set up a new organization, a special bank just to take over these debts in order to avoid the local banks going bankrupt,” said steel industry consultant Xu Zhongbo.

The debt figures, revealed in papers submitted to China’s parliament this month, highlight the dilemma facing state firms grappling with surplus capacity and how difficult it will be to pull off this central plank of Beijing’s economic reform plans.

Costs for the estimated 1.3 million coal-sector layoffs alone are as much as 195 billion yuan, and coal industry delegates attending parliament urged government to provide more support to deal with the mounting debts of hundreds of stricken “zombie” firms.

The four sectors targeted in the battle against overcapacity owe around 10.2 trillion yuan ($1.56 trillion), according to documents submitted to parliament by Wang Mingsheng, head of Anhui-based coal firm Huaibei Mining.

China’s statistics bureau puts coal and steel debts alone at 8 trillion yuan, of which about a third is bank debt.

If 20% of that goes bad in 2016, which industry analysts say is not unrealistic, it would raise Chinese banks’ non-performing loans by nearly half.

Bankers say city and regional banks set up by party or provincial government officials are most exposed, and that official NPLs, which already doubled last year, underestimate the scale of their problem lending.

China’s banking regulator didn’t return a request for comment, though earlier in March sent notices to joint-stock banks and city commercial lenders to boost risk assessment and collateral valuations to control exposure to industries suffering overcapacity.

A lawyer who handles steel industry non-performing loans for mid-sized Chinese banks said: “Banks’ fear is not without reason. The steel sector’s continued slump increases the difficulty of disposing of outstanding non-performing loans.”

In plans published in February, Beijing promised to slash 100-150 million tonnes, or up to 12.5 percent, of crude steel capacity and as much as 500 million tonnes, or 9 percent, of coal production in over three to five years.

The February policy documents said China would create a special mechanism to restructure industry debts and non-performing assets while introducing incentives to write off bad debts or transfer them to specialist asset managers, but officials said more specific measures were required.

“To cut capacity we cannot just shout slogans and issue targets – we must have a realistic and effective mechanism,” said Wang at Huaibei Mining Group.

 

Source : fortune.com

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