The State Council report follows closely on several incidents in recent months that exposed mounting opposition by banks to the debt swap program. In July, the Dongbei Special Steel Group Co., a state-owned enterprise, announced that it would abandon plans to transfer 70 percent of its outstanding debts to equity after creditors raised concerns that it would simply allow Dongbei to dodge its debts without undergoing substantive restructuring. Zoomlion Heavy Industry Science and Technology Co. and Ansteel Group Co., both also state-owned, backed away from similar plans after meetings with creditors. In all three cases, the banks noted the difficulty of assessing the value of equity converted from debt and questioned the worth of equity stakes in chronically underperforming businesses.
The opposition from traditional creditors — especially from those supporting state-owned enterprises in industries such as coal and steel, host to a disproportionate share of China's so-called zombie companies — helps to explain the State Council's desire to let a wider range of entities enter the debt swap business. That could allow, for instance, business partners or suppliers to convert accounts receivable for an underperforming firm into equity stakes in the company. In theory, suppliers, partners and parent companies in the same industry as indebted firms would be more inclined to swap pending payments for equity stakes. If this proved true, the program could also contribute to Beijing's broader goal of consolidating industries long hobbled by overcapacity.
In short, allowing businesses outside the banking sector to serve as creditors in the swap program could, if successful, accomplish several goals at once. First, it would help lower corporate debt levels. In particular, it would help address the dire state of much of China's state-owned sector, which accounts for more than half of outstanding corporate debt despite producing only one-fifth of the country's GDP. At the same time, it would contribute to consolidating many of those same state-owned enterprises in some of the country's most troubled industries. Finally, it would lower borrowing costs for still-viable firms by allowing them to dispose of some of their outstanding debts. In this sense, the debt swap program is one of a raft of measures that Beijing is pursuing to provide some relief for businesses in an otherwise unpromising economic environment. Other initiatives include a recently announced plan to provide 500 billion yuan ($75.3 billion) in tax cuts or exemptions for small businesses, a 1 percent cut in logistics costs and expanded access to foreign debt markets.
Though the corporate debt-to-equity swap program is still in its infancy, it seems increasingly clear that it will be in place in some form, and perhaps on a nationwide basis, by the end of 2016. It remains to be seen how popular, and thus how effective, the program might be. Unlike banking sector reforms in the late 1990s, when Beijing created four new asset management companies (or "bad banks," as they were called) to buy nonperforming debts from major state-owned banks, this debt swap program will involve not only "good" banks but also, potentially, other businesses. The program is unprecedented and therefore untested. This fact is clearly reflected in the hesitance by banks, and in turn, in Beijing's openness to work around bank hesitation by opening the market further.
It is also unclear how Beijing will maintain effective oversight when and if entities other than banks — especially non-state actors — enter the debt swap market. Since many local governments have a powerful incentive to prop up failing businesses, it is not hard to imagine the many ways in which a poorly regulated debt swap market could spiral out of the central government's control. But given its choices — a functioning if rambunctious debt swap market or a corporate debt crisis — Beijing may be willing to take those risks.