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ZHU RONGJI ON THE RECORD
The Road to Reform 1991-1997
By Zhu Rongji, June Y. Mei
Brookings Institution PressCopyright © 2013 FOREIGN LANGUAGES PRESS
All rights reserved.
Clearing Up Triangular Debt Must Start with the Source—Fixed-Asset Investments
September 3, 1991
This conference has several distinctive features. First, the leadership attaches great importance to it, and the State council is very supportive of the clearing up of triangular debt. The State council is very determined and has allocated RMB 35 billion to support the clearing up. Second, this conference isn't treating the clearing up of arrears solely as a fiscal settlement or a financial issue. Rather, it is dealing with the problem of triangular debt comprehensively, by not only clearing up arrears in fixed-asset investments, but also by using "linking reductions to loans" to control the stockpiling of finished goods. Next year we'll further invest in technical upgrading, which will include using US$1.5 billion annually of our national foreign exchange holdings to import advanced technology, and will gradually reduce enterprise payments to the "Two Funds," thereby improving the ability of enterprises to repay and to upgrade. Third, we're combining the tangible with the intangible, studying a series of State council policy documents while also drawing up highly operable methods and sharing the actual experiences of the Northeast region in arrears clearance. Fourth, this conference has emphasized the integration of both the payment and the prevention of arrears in order to prevent the emergence of new arrears. Our attendees have found this approach very productive and feel more confident about clearing up arrears.
Now I'd like to say a few words in response to the issues brought up here.
We Have to Focus Hard on Fixed-Asset Investments—the Source of These Arrears—and Strive for a Good Outcome in Arrears Clearance
Many people still have a "wait and see" attitude toward triangular debt, and they're not very confident. I feel that this problem can't be resolved without determination. Last year, we gained some experience and had some success in clearing triangular debt, but because of deep contradictions that had built up over many years and are impossible to resolve in a short time, new arrears were appearing even as old ones were being paid off. With debts being paid off and run up simultaneously, arrears were growing larger and larger.
Several indicators from the first half of this year show that the rate of production is quite high. From January to July, the value of state-owned enterprise production in the national budget increased by 10.4% in comparison with the same period last year, and sales revenue increased by 15.6%, yet realized profits fell by 13.1%. The proportion of loss-making enterprises reached 36.7%, which is 2.7 percentage points higher than in the same period last year, while losses amounted to RMB 17.78 billion, which is 18.6% higher than for the same period last year. Finished goods locked up RMB 133.25 billion, and inventory was RMB 70 billion higher than normal levels.
The contradiction between a rising rate of production and a lower economic return hasn't been resolved. In the first half of this year, the number of and total investment in new infrastructure projects around the country valued at more than RMB 50,000 were, respectively, nearly 100% and 80% higher than in the same period last year, while the scale of state-owned investments grew by 18%. A very large part of the production rate and of fixed-asset investment is sustained by owing arrears to production enterprises.
The national and local governments as well as the enterprises are all under very intense pressure, which they have trouble coping with, and all regions, departments, and enterprises are loudly demanding that triangular debt be cleared up. Deputies to the National People's Congress and members of the Chinese People's Political Consultative Conference have tabled several dozen proposals for clearing up these debts. Many older comrades are also very concerned about this issue and have made many valuable suggestions. In particular, many people at the grassroots level have written letters with suggestions, and their zeal is touching. I feel that the time is ripe to resolve this problem.
The State Council attaches great importance to the problem of triangular debt. In late May, Premier Li Peng entrusted me with this task. On June 1, he chaired a Premier's work conference that conducted a special study of this topic and proposed to make a breakthrough by using the clearing up of triangular debt to invigorate large and medium state-owned enterprises and improve productivity. We are expected to make a breakthrough in this regard within six months.
Major Reasons for New Arrears. Based on an analysis of the arrears clearance situation last year, the State Council's leading team on triangular debt believes that there are three major reasons why new arrears are accumulating even as old ones are being paid up.
—The first is the serious shortfall in fixed-asset investment, resulting in massive arrears owed to production enterprises for equipment and materials, as well as to contractors for project funds. Construction is completed but still hasn't been paid for, so the production enterprise has to assume the debt and pay the interest for the developer. Last year alone, arrears amounted to RMB 50 billion, causing production and contracting enterprises to pay RMB 5 billion in interest.
—The second is enterprise losses. Enterprises that lose money are supposed to be shut down, but for various reasons this hasn't been done, and they even continue to produce, running up arrears because they're unable to borrow. In last year's budget, state-owned industrial enterprises openly acknowledged losses of at least RMB 50 billion. This doesn't even count concealed losses, which appear to be profits but are actually losses. As a result, these enterprises owe working capital to other units.
—The third lies in over RMB 70 billion of stockpiled goods, which are locking up working capital. In order to maintain production, enterprises have no choice but to run up arrears.
These three factors have been responsible for almost RMB 200 billion in triangular debt. Furthermore, the trading of goods is disorderly, settlement discipline is lax, and credit is poorly understood—also important causes of worsening triangular debt. These and the above three sources have created serious triangular debt.
Any assessment of the seriousness of triangular debt must look at it from two perspectives. On one hand, it should be seen as the manifestation of deep contradictions that have built up over many years and can't be resolved in a short time. We plan to resolve them within three years. On the other hand, we must recognize that they can indeed be resolved if appropriate measures are taken. This year, we want to clear up RMB 100 billion—this is an attainable goal. However, it's quite risky to tackle all three sources at once. Last year, we put RMB 50 billion into paying off arrears. Of this amount, RMB 10 billion went toward clearing up arrears for infrastructure projects, with effective results. If we start by clearing up the fixed-asset investment arrears of projects, each debt paid will be one debt less, and this won't create any new arrears. However, if we start with arrears of working capital, this might lead to new stockpiling. The State Council has agreed to start at the sources and feels that we must be cautious in clearing up working capital arrears.
A Pilot Program for the Northeast. We have also decided to start a pilot program for triangular debt clearance in the Northeast, which will constitute the first stage of nationwide clearance. The method proposed to resolve the stockpiling of goods in the pilot program is "linking reductions to loans." In july and August, the State Council sent clearance work teams to the Northeast and other regions in conjunction with the pilot program.
According to a study of typical cases in the Northeast, arrears of fixed-asset investments account for only 15-20% of total arrears. Many people are skeptical about starting with fixed-asset-investment arrears, thinking this won't resolve the problem. Similar views have been voiced at this conference. We've often repeated this fact: fixed-asset-investment arrears may constitute a very small proportion of total arrears when counted as single debts, but this doesn't factor in the overlapping effect of serially linked arrears. If you put money into a power plant that is in arrears, it will be able to pay its equipment manufacturer, which will then pay the steel mill, which will in turn pay the coal mines and railways. Because of this overlap, the effect is magnified, and RMB 1 invested can clear up RMB 3-5 of arrears.
The pilot program in the Northeast hasn't ended yet, but so far has already achieved a 1:3 clearance ratio, that is, RMB 1 will clear up RMB 3. If this is done well, it looks like we can achieve ratios of 1:4 or 1:5. The Northeast pilot program proves that clearing arrears by starting with fixed-asset investment doesn't create new burdens and doesn't expand the scale of infrastructure construction. Rather, it clears up old debts and is workable, effective, and risk-free.
Sequence of Clearing Arrears. There have been loud calls at this conference for clearing arrears of working capital as a first step, owing to misgivings about the effectiveness of starting at the source of fixed-asset investment arrears. Some have also argued that most fixed-asset-investment arrears come from projects with poor returns or lack of funding, and that putting money into them would only make us assume new burdens. We respond that it will take three years to finish clearing up arrears created by fixed-asset-investment shortfalls. For now we should first clear up the arrears of projects with good returns, and of large and medium projects. I'm in favor of clearing arrears in this sequence, and there are specific requirements in the implementation plan.
As for projects with poor returns, it's not that they aren't repaying any debts they owe. There are quite a few projects of this sort, and if they were all failing to repay, the production enterprises wouldn't be able to survive. The investment quota is already used up. If the developing unit doesn't pay the unit that produced the raw materials and doesn't pay the project costs of the contracting enterprises, then the producers and contractors can only maintain production by borrowing from banks, which is equivalent to paying the interest for the developing unit. This is transferring the burden of the shortfall in construction funds onto the producing and contracting enterprises. This is one of the main reasons why large and medium core enterprises are in such difficulties. Therefore regardless of whether a project's returns are good or poor, it must repay. If the developing unit can't pay, then the bank loan should be made to that unit, and it should pay the interest, rather than letting production enterprises bear the burden. This is the only way to set the financial order straight.
If we inject money to clear fixed-asset investment arrears, will that increase the credit quota? Will there be risk? I say there will not—at least theoretically it should not increase the credit quota. When a developing unit owes money to a production enterprise, the latter borrows from the bank to sustain production. Now the bank will give the fixed-asset-investment loan to the developing unit, which will use it to repay the production enterprise, and the enterprise can then repay the bank. Overall, there will be more loans for fixed-asset investments and fewer loans for working capital. There won't be an increase in the total volume of loans, only an adjustment in the structure of the loans. Of course, this is only speaking theoretically. In practice there will inevitably be some delays and losses, and funds invested will be greater than funds recaptured.
To resolve the problem of triangular loans, it will be necessary to increase lending, but there's no great risk. And once the money starts flowing, we'll still have to draw up a sequence (of steps) to ensure, to the greatest extent possible, that the funds don't flow to enterprises that have stockpiles of goods. The hardest thing will be to offer money to some enterprises for repaying their debts, but then find that they refuse to borrow, preferring instead to stay in debt and not even paying interest. That won't do! There still has to be administrative intervention—we must order them to borrow. Why is it that they never gave a thought to repayment when they were proposing projects, seeking approvals, and starting up construction? If you're in debt, you have to repay.
Guarantees. Some provinces say that because of natural disasters enterprise returns are poor, local government revenues have gone down, and it's hard for them to raise money on their own. Funds injected need government guarantees, but government leaders have reservations about giving them. We say that guarantees are needed because these funds are supposed to be raised by the local governments and enterprises themselves, yet for the time being you can't raise them, so the only option is for the banks to lend to you, but the governments must guarantee repayment.
When launching a project, you thump your chest and say you have the money. Perhaps at the time you had only a certain amount but used it several times. When starting up the first project, you may have said you had RMB 100 million. When starting up a second project, you may have again said you had RMB 100 million. When starting up a third project you still said you had that amount. Now that "one daughter has been married off several times," when the work starts there's no money. So in restoring normal economic order and clearing up old debts, locals will indeed have difficulty raising funds. The banks can lend to them but will require fiscal guarantees from the local governments, which must repay the banks in the next fiscal year. If local fiscal authorities won't give guarantees and won't repay, they may still plan to start up major projects the next year, and then the scale of construction will truly grow larger than ever.
Guarantees are a measure to prevent new arrears. Self-raised funds account for 30-50% (of total project costs), which is quite high. If banks don't put in some money and enterprises aren't able to raise any money on their own, then the effort to clear arrears won't yield the desired results. In order to support key national industries and infrastructure projects as well as key technical upgrading, the State Council has decided that this year, the Construction Bank and the Industrial and Commercial Bank will jointly issue RMB 10 billion of national investment bonds. Of this sum, 8 billion will be used for infrastructure and 2 billion for technical upgrading; amounts have already been allocated to the various provinces and municipalities. Before the bonds are issued, we'll ask the banks to lend to the locals, and the local governments will guarantee these loans. Once the bonds are issued, the locals will repay the banks. These will be considered self-raised funds and will still require guarantees. In short, if you can't repay this year, you'll have to repay next year, and if you can't repay next year, you'll have to repay the year after, but you can't let the debt go bad.
Some provinces and municipalities have indicated that they have difficulty raising funds, and I do understand. That's why the self-funded portion will be suitably reduced for the provinces and municipalities experiencing greater difficulties, and we'll give them more bank loans. However, I still hope that all of you here will report to your provincial Party committees and governments after you go home—cut back a bit on the projects planned for next year and do fewer of them, and cut back especially on those projects to build fancy buildings. Take some of the funds reserved for those projects and use them to pay back money you owe others. That way, things will start moving for everyone.
We hope that through our joint efforts, we'll be able to clear up RMB 100 billion this year. That's about one-third of the current triangular debt, perhaps even a bit more. In October we should calculate the results of the clearing up to shore up everyone's confidence.
We Must Resolutely and Steadily Shrink Stockpiles and Do a Good Job of "Linking Reductions to Loans" and Clearing Arrears of Working Capital
Many provinces and municipalities have reported serious arrears of working capital, and are pressing loudly to have these arrears cleared up. I want to stress that we have to be very cautious in clearing up arrears of working capital. We can't just "add flour if it's too watery and add water if it's too floury." We have to use desperate measures to shrink the massive inventories and then put the money from downsizing inventories into technical upgrading and technology development. Only then can we achieve the desired results. This is because the stockpiling of inventories is a major source of arrears of working capital.
Excerpted from ZHU RONGJI ON THE RECORD by Zhu Rongji, June Y. Mei. Copyright © 2013 FOREIGN LANGUAGES PRESS. Excerpted by permission of Brookings Institution Press.
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