CHINA’S campaign to slim down its bloated industries could be derailed by more than US$1.5 trillion of debt in its steel, coal, cement and non-ferrous metal sectors, which threatens to overwhelm local banks.

    Tackling industrial overcapacity has become a priority for the government to make its slowing economy more efficient and address a supply glut that has hammered coal and steel prices.

    China is providing more than 100 billion yuan (US$15 billion) in the next two years to handle layoffs from coal and steel, but that will only be made available once debts have been settled.

    Critics say there is no clear mechanism for tackling the debt burden, which will put huge strain on the weakest sections of the banking sector.

    The debt figures, revealed in papers submitted to China’s parliament this month, highlight the dilemma facing State firms grappling with surplus capacity and how difficult it will be to pull off this central plank of the government’s economic reform plans.

    Costs for the estimated 1.3 million coal-sector layoffs alone are as much as 195 billion yuan, and coal industry delegates attending parliament urged the government to provide more support to deal with the mounting debts of hundreds of stricken “zombie” firms.

    The four sectors targeted in the battle against overcapacity owe around 10.2 trillion yuan, according to documents submitted to parliament by Wang Mingsheng, head of Anhui-based coal firm Huaibei Mining.

    China’s statistics bureau puts coal and steel debts alone at 8 trillion yuan, of which about a third is bank debt.

    If 20 percent of that were to go bad in 2016, which industry analysts say is not unrealistic, it would raise Chinese banks’ non-performing loans by nearly half.

    Bankers say city and regional banks set up by Party or provincial government officials are most exposed, and that official NPLs, which already doubled last year, underestimate the scale of their problem lending.

    “China needs to set up a new organization, a special bank just to take over these debts in order to avoid the local banks going bankrupt,” said steel industry consultant Xu Zhongbo.

    The banking regulator didn’t return a request for comment, though earlier in March it sent notices to joint-stock banks and city commercial lenders to boost risk assessment and collateral valuations to control exposure to industries suffering overcapacity.

    A lawyer who handles steel industry non-performing loans for mid-sized Chinese banks said, “Banks’ fear is not without reason. The steel sector’s continued slump increases the difficulty of disposing of outstanding non-performing loans.”

    As well as seeking cuts in value-added tax and relief from expensive “social functions” like healthcare and education, the coal delegates urged the government to provide additional funding and policy support, and establish “debt-to-equity” mechanisms to handle the problem.

    “Because the mechanisms and related policies for State-owned firms exiting the market are not complete, closing them will raise thorny problems like the settlement of debts,” said Liang Tieshan, chairman of the Henan Pingdingshan Coal Group.

    Average debt-to-equity ratios at steel firms rose 1.55 percentage points to 70.1 percent in 2015 and for at least five firms exceed 100 percent, figures from the China Iron and Steel Association show. Coal executives estimate their sector average exceeds 75 percent.(SD-Agencies)