Put together Raphael Lam, the Resident Representative of the International Monetary Fund (IMF) in China, and some 140 CFOs and other senior finance executives in a Shanghai ballroom – and wait for the fireworks to start.
Well, not firecrackers and Roman candles, exactly. Lam, who earned a PhD in economics from University of California in Los Angeles and has working experience at the Hong Kong Monetary Authority, was measured and sober at the 5th CFO Innovation Shanghai Forum, as were those who asked him questions from the floor.
Corporate debt at risk in China is climbing up sharply, and could potentially cost the banks losses equal to 7% of GDP
But Lam was uncompromising in his assessment of where China’s economy is going. While he believes that a hard landing (read: sharp slowdown or recession) is unlikely and that the rebalancing of the economy towards consumption is progressing, he also notes that the country’s medium term GDP growth target of 6.5% to 7% is ambitious and “could lead to unsustainable stimulus.”
The right balance must be struck in managing the growth slowdown and in advancing reforms, said Lam. He acknowledges steady progress on financial and external sector reforms, but says action on state-owned enterprises is lagging. “China needs to address vested interests,” added Lam, and should also “foster fiscal, hukou [household registration] and pricing reforms.”
Corporates under strain
“The credit level is too high and rising rapidly,” he warned. “There is a need for a bolder debt restructuring plan, with potential bank recapitalization.” Corporate debt at risk is climbing up sharply, and could potentially cost the banks losses equal to 7% of GDP, Lam said.
What caught the most attention, though, is a chart that shows a sharp rise in payable days (computed using the formula account payable/sales*365). Already much longer than in all other countries at around 55 days in 2009, days payable in Chinese companies are estimated to have surged to more than 75 days last year (see chart below).
Corporate Financing Strains, in payable days
Source: International Monetary Fund
That was no surprise to the Asia CFO of one specialty paints multinational company, who said that some of the company’s customers in China are delaying payments for up to ten months. Speaking at the sidelines of the conference, this CFO said he was seeing signs of strain among the company’s suppliers, one reason why he is wary of also delaying payments to them. There are relatively few specialty suppliers in the business, so the loss of some vendors could pose difficulties across the supply chain.
Counting on credit insurance
Onstage, the finance chief of a logistics company said she follows the 80-20 rule – those customers that account for 80% of sales are dealt with differently than others that do not do as much business with the company. The contracts allow for fines to be imposed for late payments, but that is seldom applied in China, particularly for large customers like state-owned enterprises (SOEs).
SOEs eventually pay, said this CFO, though the wait is getting longer these days. Moves by the government to reform the SOE sector and deal with “zombie” SOEs are a concern, in the sense that entities formerly assumed as enjoying government support may now be at risk. This evolving SOE environment could also affect the credit insurance coverage the logistics firm takes out on certain accounts.
One participant floated the idea that online behavior could serve as an indicator of a company’s ability and willingness to pay its debts
Credit insurance is one of this CFO’s go-to strategies. She believes the judicious use of credit insurance lowers credit risk without unduly adding to costs. It’s not all plain sailing, though. One questioner asked about credit insurance providers lowering credit limits on SOEs and other companies. The finance chief said she had, indeed, seen that happen, a move that threatened to upend the credit risk management program she has put in place.
She has spoken to the insurance company and found that one of the issues is lack of information. For the insurer, the better part of valor is to lower credit limits when there is not enough data to make a judgement on a company’s creditworthiness. What this CFO did was to help the provider find more information on the company, which persuaded it to raise the counterparty’s coverage limit.
From another perspective, the credit insurer’s action on credit limits or its decision to decline coverage can be useful inputs for a company’s own credit risk management. As a client, the logistics CFO said she has access to the credit insurance provider’s database, which is a useful resource when the sales folks pursue a new account or when pricing decisions have to be made with regard to these accounts.
Such access supplements the credit department’s research efforts and allows finance staff to focus attention on counterparties that are not in the credit insurer’s database. Asked whether it was a good idea to engage the credit insurer to conduct research on a counterparty that is not on its database, the CFO pointed out that the company will be charged for this service. This is what the company’s own credit department should be doing in the first place.
Leapfrogging to the future
While the situation is improving, the availability of information and transparency even of listed companies is still a work in progress in China. In a panel discussion on alternative financing, one participant floated the idea that online behavior could serve as an indicator of a company’s ability and willingness to pay its debts.
Such correlations are already being made in more advanced markets. For example, US lending platform Kabbage (and its Australian subsidiary Kikka Capital) uses online datasets and algorithms to make loans to small and medium sized companies. In China, online lenders MYbank and WeBank extend credit to private companies, farmers and consumers based on online transactions in marketplaces like Alibaba and offline due diligence.
But the panelists, who included a representative from a financial technology (fintech) start-up, cautioned that it’s still early days for many of the online platforms. In particular, regulation and oversight of peer-to-peer lending platforms leave much to be desired. Earlier this year, Chinese authorities charged P2P lending company Ezubao of being, in reality, a Ponzi scheme that bilked 900,000 investors of US$7.6 billion.
Still, fintech and other technologies can help companies in China survive and thrive in volatile times. One CFO of an enterprise that makes sausage casings said her company has launched a B2C business aimed at the do-it-yourself (DIY) market to supplement the traditional B2B business by setting up online storefronts on Taobao, China’s leading e-commerce platform.
Sausage manufacturers want lengthy intestines, while DIY consumers want them shorter. The problem has been how to reach these consumers. With the Internet and the rise of e-commerce platforms, said the CFO, companies now have an affordable channel to set up a B2C business. She said that the Taobao storefronts are easily set up and the cost is minimal. The online payment system is also efficient and cost-effective, and generates real-time data for analytics.
CFOs can do a lot with the bread-and-butter aspects of financial management, including mitigating the hit on payables and financing. But much more is now required of finance
Up the value chain
Beyond day-to-day financial management, the CFO Innovation Shanghai Forum also provided insights into business models and long-term strategies in China. One CFO said his company is upgrading its equipment to further move up the copper manufacturing value chain. The goal is to intensify production of high precision copper plates and strips, which are used by the electronics, telecom equipment, automobile components and transmission devices industries.
There is a glut of players in the lower reaches, such as miners and basic-materials processors. But there is a dearth of companies in the precision space, which is understandable because substantial capital, advanced technology, sophisticated skill sets and, yes, complex financial management are required the higher a business moves up the value chain.
This CFO believes that the higher his company is in the value chain, the better its chances of delivering long-term sustainability and profitability to stakeholders, including investors and the workforce.
It’s an approach that the IMF’s Lam agreed with, adding that this strategy is applicable not only in industry but even in services, notwithstanding that China's government policies are oriented towards encouraging consumption and cutting away at the glut in industrial capacity.
CFOs can do a lot with the bread-and-butter aspects of financial management, including mitigating the hit on payables and financing. But much more is now required of finance in an economy in transition, as China is – and indeed in any other Asian economy, given the volatile global economic environment and the rise of digital competitors everywhere.
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation. He co-chaired the 5th CFO Innovation Shanghai Forum on April 21, 2016.
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