How China dealt with overcapacity and reformed SOEs in 1998 12-14-2015

The overcapacity in China today is quite similar to the time in 1998. The current China government could probably learn from the successful experience back in 1998 to deal with the overcapacity today.



How to deal with the overcapacity in different industries has become a decisive battle in today’s China economy.


17 years ago, China was facing the same problem. At that time, the rapid placement of credit loans resulted in overcapacity in textile and other industries, misuse and misdistributions of the loans from the banks, and big loss in state-owned enterprises (SOE). Fortunately, China solved such a problem through a series of reforms.


During 1998 to 2002, starting from the textile industry, the China government dealt with overcapacity through reorganizations on the bankrupt enterprises, letting Asset Management Corporations (AMC) undertake the responsibility of the banks to deal with the non-performing /bad debts and etc. Probably, China can learn from this experience to deal with the current overcapacity.


Overcapacity in 1998


After President Deng Xiaoping’s southern tour in 1992, China was greeted by a climax of investment. With a large number of loans, the enterprises kept constructing, however, there was not enough demand in the market, which had left a large amount of inefficient capacity in that 4 years’ time.


Meanwhile, the institutional barriers in China stood in the way of de-capacity and de-leverage. How the banks should issue the debts didn’t depend on the credit performance of the enterprises who wanted to borrow money. The banks that time didn’t examine the qualifications of the enterprises, but just issued the loans easily if it was one of the SOEs. Thus, the money or debts was seriously misused and mis-distributed. The loans kept flowing to the SOEs which were in deficit.


Moreover, the inflation led by the excessive investment had tightened the monetary policies during 1994 to 1996. Also, Asia financial crisis in 1997 had decreased the demands in different industries.


Asia financial crisis in 1997 put direct pressure on China’s export from demand to supply, which had exposed the problems of the excessive expansions in capacity from SOEs and had strengthened the determination for the government to begin the reform.


The main problems that exposed during that period:

1. The overcapacity occurred in the consumer goods from downstream while the overcapacity didn’t occur in the capital intensive industries from upstream, such as Steel Industry, Petroleum and Transportation;


2. The SOEs were in deficit and the capacity efficiency rate in different industries was less than 40%;


3. Serious debt problems occurred in the China’s economic: chain debts and high non-performing loans (NPL) ratios in banks (NPL ratio was up to 30% in the late of 1990s);


4. The financial pressure was intense and the China government also had to face the pressure from the foreign debts.


5 actions to deal with overcapacity


To solve the problems of overcapacity, the government led by Premier Zhu Rongji took the following actions:

1.       Maintain neutral and tightened monetary policies to force the enterprises to de-capacity and de-leverage. In 1998, Premier Zhu stated that “there are 2 things that cannot be done”: banks cannot loosen the monetary conditions and the redundant constructions for capacity are forbidden.


Before 1998, China had the moderately tightened monetary policy; in 1998, the proper monetary policy; in 1999, prudent monetary policy. Thus, the bank wouldn’t lend out a large number of loans just because of the slowdown of the economy.


2.       Restructure the supply-side by administration means: End the redundant projects for capacity, clear away the overcapacity, merge the bankrupt enterprises and redirect laid-off workers.


During 1996 to 1998, the number of SOEs had decreased from 113.8 thousand to 65 thousand, down by 42%. In 1998 to 1999, about 22 billion workers in SOEs were fired.


3.       Encourage the enterprises to share its shareholding and encourage people to invest in the enterprises. Let the Asset Management Corporations (AMC) help the banks to deal with their non-performing debts.


Four biggest AMCs (Asset Management Corporation of Great Wall, Cinda, Huarong, Dongfang) were provided money and loans by the Ministry of Finance and the Central Bank of China.


Then the AMCs issued the special financial bonds to specific commercial banks and used the loan to undertake the non-performing debts from the four biggest banks in China (Bank of China, China Construction Bank, Agricultural Bank of China and Industrial and Commercial Bank of China). It also helped the banks to restructure their debts and make the banks be able to lend money again. During 1999 to 2005, 2.58 trillion yuan of non-performing loans was removed from the banks and undertook by the AMCs.


4.       Implement the proactive fiscal policy which aims at issuing long-term additional treasury bonds. In 1998, China began to implement the proactive fiscal policy. That year, the government issued 100 billion yuan long-term additional treasury bonds and supported the infrastructures for agriculture, forestry, water conservation, transportation and electrical network through 100 billion yuan bank loans.


The government also overhauled 727 terms of unauthorized collection of fees and reduced the financial burden about over 37 billion yuan on enterprises and society.


5.       Restructure the demand-side to increase the demands: real estate reform, tax reform and exchange rate reform.


After the real estate reform in 1998, the real estate had become a new growth area. The rapid urbanization, thanks to the reform, helped digest the manufacturing capacity. The tax sharing reform in 1994 had fulfilled the treasury warrant. Moreover, China had an exchange rate reform (The official RMB exchange rate was linked with the foreign exchange swap price. China began to implement the system of floating exchange rates based on supply and demand) and one-off RMB devaluation in 1994, and it had led to an exported-oriented economic system. After the year of 2000, the export volumes began to grow again and helped to digest the overcapacity.


Good effects


A series of actions to de-capacity showed its good results very fast. Also, changes happened on the micro-economic level when dealing with the overcapacity.


The number of SOEs had decreased. During the reform in 1998 to 2002, with the bankruptcy and mergers in many enterprises, the increasing number of industrial enterprises began to slow down, and the number of SOEs as well as its proportion of the total the enterprises began to decrease.


The number of the big-loss enterprises had decreased. Till the end of 2000, the rate of the big-loss SOEs had decreased from 39.1% to 20%. Most of the 6599 big-loss enterprises had turned from loss to profit.


The side-effect


One of the biggest side-effects was that the huge number of unemployed workers made the residents cut down their assets. Though the government had helped the people who lost their jobs to find new employment, it was very difficult for such a large number of unemployed people to find new jobs again, which had bad effect on the living conditions and the domestic demands.


*This article is a translated and re-edited version by CCM. The original article is from and written by Pan Lingfei.

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