Bloomberg News

China to Allow Debt-Equity Swaps to Relieve Funding Problems

November 24, 2011

(Updates with economist comment in fourth paragraph.)

Nov. 24 (Bloomberg) -- China will allow companies to swap debt into stock from next year, making it easier for creditors and courts to reorganize bankrupt small businesses hurt by weakening demand for exports and tighter credit markets.

Debt can be converted to equity after a court ruling or agreement with lenders, under regulations coming into effect on Jan. 1, according to a Nov. 23 statement posted on the government’s website today. The measure will help bankrupt companies restructure, said Zhou Bohua, director of the State Administration of Industry and Commerce, according to a report by the official Xinhua News Agency yesterday.

China needs to reorganize debt at companies including more than 6,500 set up by local governments, the National Audit office said in June. Concern over default risk caused the difference in yields on AAA rated Chinese companies’ five-year notes and similar-maturity A rated debt to widen 55.6 basis points this month to a record 462.5 yesterday, according to Chinabond data.

“It is a necessary development for a country that is still lacking in experience dealing with bankruptcy,” Ken Peng, a senior economist with BNP Paribas SA in Beijing, said in a telephone interview today. “But it has the vibes of another roundabout way to get financing for certain interest groups, with uncertain outcome for investors.”

Credit Squeeze

Medium- and small-sized companies are facing funding difficulties because of the global financial crisis, Xinhua cited Zhou as saying. The move will help businesses reduce debt and resolve financial problems, he said.

Small businesses in China have been facing a credit squeeze after the government tightened monetary policy to cool inflation. More than 80 businessmen in the city of Wenzhou in Zhejiang province have disappeared, committed suicide or declared bankruptcy to avoid repaying debts to informal lenders since April, Xinhua reported in September.

Chinese Premier Wen Jiabao said last month that economic policy will be fine-tuned as needed and the industry ministry said it planned to study “stimulative policies” for smaller companies. Officials will make adjustments at a “suitable time and by an appropriate degree,” Wen said in a statement published Oct. 25. The Ministry of Industry and Information Technology and other government agencies will work to help small businesses facing difficulties, it said separately in a statement Oct. 26.

Economic Fine-Tuning

“All these small fine-tuning measures may not have much impact,” Liu Li-gang, a Hong Kong-based economist at Australia & New Zealand Banking Group Ltd., said in a telephone interview today. “They should create a more relaxed monetary policy condition then there’s an incentive to lend more to small- and medium-sized enterprises.”

The central bank yesterday cut the reserve ratio for more than 20 rural credit cooperatives nationwide by half a percentage point, according to an announcement from its Hangzhou branch in Zhejiang, where small businesses have complained about lack of access to credit.

Premier Wen ordered the first audit of local-government borrowing in March, amid concern spending designed to support the economy following the 2008 global financial crisis would leave a legacy of bad debt. The June report found the companies’ finances were “quite weak” and they were too often relying on land sales to repay debt.

Local governments in China set up financing companies to fund the construction of roads, sewage plants and subways after they were barred from issuing debt directly to investors under a 1994 budget law. This year they’ve been allowed to sell debt directly for the first time, with Shanghai and Guangdong, on China’s southern coast, selling debt.

“Local government financing vehicles facing solvency problems may find this to be a great opportunity to turn their bank debt into equity,” BNP Paribas’ Peng said. “But what would or could banks do with that equity? Can they sell it? If so, to whom?”

--Henry Sanderson, with assistance from Chua Baizhen in Beijing. Editors: Shelley Smith, Katrina Nicholas

To contact Bloomberg News staff for this story: Henry Sanderson in Beijing at

To contact the editor responsible for this story: Shelley Smith at

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