One of the likely outcomes of China’s rising debt will be a shortage of liquidity for more remote geographic regions, along with corporates with little access to the power centers in Beijing. One short-term solution is the debt-for-equity swap program, which is allowing local SOEs to place the debt in the banks in the form of equity, and permitting these firms to continue to borrow from the banks. This is one tool that is keeping local governments — and their ailing state firms – alive.
However, although this program has come from Beijing, the leadership has been reluctant to allow local governments full control over the swap as it encourages continued waste of capital in inefficient, older industries. It may use political methods – the anti-corruption campaign – for fiscal ends.
Right now, the poster child for this struggle for capital is occurring in Liaoning Province over the debts of Dongbei Steel. The outcome of this dispute will signal Beijing’s policies toward SOE debt restructuring.