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Sunday, 11 March 2012

Toxic loans and all that...

Satyajit Das, a China scholar has written a piece for ABC TV (in Australia) which surveys much of the misalignment in the Chinese economy and links well some of the different concepts (like over-investment and over-indebtedness) which have been covered in this blog and elsewhere.  It can be found here.

A good question you might ask is why an Australian TV channel?  Well it just so happens that people in countries like Australia and Canada (key exporters to, and dependent on, China) are starting to ask what could happen if China's growth slows (more than currently) and the answers are not simple or necessarily complementary.  More on this in a moment.

A loan for every occasion

The point has been made in several places that the Chinese banking system is weighed down by a variety of different loans, the two major types being (i) legacy loans prior to 2008 which had been accumulated over decades (often to state-owned entities) which were in default or non-performing and (ii) loans directed to be made after 2008 encouraged by bullish central government policy aimed at stimulating the Chinese economy.

As has been mentioned the first type of loans were hived off from bank balance sheets - often into separate run-off vehicles called Asset Management Companies (or AMCs).  As this article on a WSJ blog explains, the AMCs have failed to recover and dispose of the bad debts, and strangely enough are still operating and looking for new investment (possibly through IPOs).  An article by Simon Rabinovitch for the FT details proposed injections of funds from Standard Chartered and UBS. It also mentions a lucrative side venture the AMCs got into - snapping up bank licences.  This is not the only venture - apparently AMCs have been investing in the real estate sector, and in distressed real estate vehicles aswell.   As the WSJ article made clear, debt resolution companies should not have ongoing business (well, unless they are owned by the UK government!).

So far, so well hidden, but added to this is a weight of recent government supported lending.  During mid 2011, the full extent of a lending binge was hinted at when it was findings by the National Audit Office and the People's Bank of China were released, including the headline figure that Chinese local governments owed a total of $1.65 trillion in debt - equivalent to 27% of China's GDP.  As this article in the FT stated
Local governments have accumulated an unprecedented mountain of debt in the wake of the 2008 financial crisis after Beijing opened credit floodgates, backing state-owned banks to lend to state-backed infrastructure projects...
while an article in Bloomberg gave some details about some of the vanity projects involved, such as the building a replica of New York City in Tianjin.  Victor Shih was one of the first to fully explore how this came about (a good summary of his analysis and in general is here) and one of the key ways was the use of trusts.  Historically local governments had been profilgate and were barred from borrowing directly and so had to seek revenue from land sales (which fed the real estate boom).  To sidestep this they would set up third party entities which were opaque and raised the financing for government projects.

Last year many trusts faced cash squeezes as revenue from the underlying projects dried up while obligations on the trusts to start repaying the loans kicked in.  The Yunnan Highway was the first platform which was reported to be close to default on loans, while the FT Alphaville blog reported the first possible default by a Chinese corporate on a bond issue.

Cleaning up

Arguably the Chinese have shown similar enthusiasm for cleaning up the debt as for building the underlying projects themselves.  In 2011 a plan equal to or greater than the US TARP was announced and this year has seen suggestions that overdue loans will be tackled with a combination of new money, rollovers and maturity extensions (see here).  Michael Pettis discusses the issue (and likelihood of success) in some detail in his latest blog post.  It should only be added that (i) similarly unusual "trust" structures have popped up in the private real estate and industrial sectors targeting businesses that cannot get credit and consumers seeking higher returns than in the regulated banking system (more on this later) and (ii) let's hope they do a better job than the photoshop artists who were asked to spruce up a shot of some local officials inspecting a newly paved road...

A newly laid road in Huili, south west China

What will the neighbours say?

China's trading partners are sensitive to unfavourable or unpredictable developments (the bans on rare earth mineral exports and Brazilian mega iron ore ships, or the arrest of Australian citizen Stern Hu, Rio Tinto's iron ore negotiator in 2009) and the recent announcement of lower growth targets saw much discussion about future prospects for countries such as Canada.  Canada has recent experience of private sector loss of confidence in China from the recent Sinoforest debacle.  However it is Australia which is perhaps most vulnerable to a China downside shock and which there has been lively debate.

The Economist identified in 2010 that the Australian property market was overvalued back in 2010 and there hasn't been any significant data to dampen that view.  Meanwhile last week S&P produced a report predicting steep falls in house prices if China growth was below target (see here).  The report was strongly criticised by Michael Pascoe in the Sydney Morning Herald, but the property market is a key focus of the Australian economy and weakness would be a strong signal for the rest of the economy.  Meanwhile and more significantly there were warnings about threats to commodity prices from a China slowdown which could be even more serious, both in Australia and globally.

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