Treasury Today Country Profiles in association with Citi

Tackling overdue corporate payments in China

Chinese man fishing with cormorants birds

While rising labour costs and the depreciating currency tend to be the issues which the mainstream financial media focus on, there are more salient concerns for corporates operating in China at the moment, not least where corporate payments are concerned. In this insight, Treasury Today speaks to Rocky Tung, Asia Pacific economist for Coface about the worrying levels of overdue payments in China.

According to a report published by credit insurance company, Coface, last month, 82% of companies in China experienced overdue payments in 2013, a 5% increase from the previous year. The research also reveals that 45% of companies believe that the value of these overdue payments is increasing and that the issue is affecting companies of all sizes from most sectors of the Chinese economy.

Root causes

“One of the main reasons attributing to the increase in overdue payments,” says Rocky Tung, Asia Pacific economist for Coface “is that many corporates are telling us that their customers are facing financial difficulties.” With the slowing of the Chinese economy, which the report highlights as a major concern for Chinese corporates, he believes that few companies saw turnover expansion last year. Companies in China are therefore finding it difficult to obtain the necessary liquidity to make payments on time, leading to an increase in overdue payments. “In addition,” says Tung, “there has been a decline in customer management which is cited as another main reason for the overdue accounts.”

The availability of credit has also been an issue. Traditionally, SMEs have suffered the most when credit conditions are squeezed, however with Chinese monetary policy tightening, restricted access to credit may now start affecting larger corporates, too. “If the government is not going to extend credit further, which 90% of corporates believe it won’t, then there will be trouble obtaining credit right at the top of the chain,” says Tung. “Overall, the system will be fuelled with less credit, so companies will increasingly have to pay more for credit from banks or turn to the shadow banking sector. This is a big concern for corporates operating in China and because of this I expect to see SMEs continue to face tight credit conditions in 2014.”

The increasing use of Bank Acceptance Drafts (BADs) may also explain why Chinese corporates are facing a rise in overdue payments. As credit conditions tighten these are becoming an increasingly popular payment tool in China. Similar to a guaranteed cheque, the drafts guarantee the payment of a debt on a future date, which can be up to six months if issued on paper or a year if issued electronically. Corporates who receive these drafts therefore have to wait to release the cash, or they can ‘cash in’ the draft at a bank – for a cost.

Spotlight on household electronics

Most industries in the Chinese economy have seen a decline in their payment experience yet three sectors in particular are cited in the report as being most at risk from overdue payments; industrial machinery, household electrics and chemicals. This is due in part to declining exports and domestic demand.

For some manufacturers in the household electronics sector, like computer machine manufacturers, their average debt to equity ratio stands at around 360%. They have also suffered from low margins over the past few years, averaging 2.4% in 2013. “These conditions are a bad sign as they can indicate that companies in this industry cannot generate operating cash flow, which can lead to defaults on payments,” says Tung. “Also, should this occur, owners of smaller companies often just abandon the business because they do not want to pay the money they owe – thereby causing damage to counterparties.”

No silver bullet

So how can corporates operating in China reduce the risk of overdue payments? “In China, unlike many western countries, information is not transparent,” advises Tung. “There are therefore many SMEs who do not have adequate information about their counterparties.” What is more, the Coface report highlights that around 40% of Chinese corporates are not using any credit management tools. For Tung this is a dangerous statistic as “companies need to protect themselves against credit defaults – and using credit management tools is one way to do this.” While treasurers can conduct some investigations into their counterparties and suitable credit management tools themselves, conversations with specialists in the field will be invaluable.

When it comes to settling an overdue payment, arbitration is one of the least favoured methods by corporates in China, the most popular being ‘amicable negotiation’. For Tung, the reason for this is twofold. “First, I would say that in developed countries, arbitration would be a more effective way of dealing with overdue payments due to the strength of their legal systems. The legal system in China has to be improved for corporates to see this as a more effective method of resolving overdue payments.” Secondly, he says, “relationships (guanxi) are a very important element of the business culture in China. I therefore expect that even if the legal system was to be improved, amicable negotiation would remain the most popular method, even if it may not be the most effective.”

In short, suppliers need to think strategically and work at a relationship level with their buyers to help counter the negative effects of delayed payments. Buyers, too, must consider the sustainability of their supply chains.