China's bad debts a cause for concern
By Edward Chancellor
Credit booms are often followed by credit busts. For those who don’t read history, this lesson has been learnt from painful recent experience. But not as far as China is concerned. The world’s second largest economy has seen a tremendous surge in lending over the past few years. The inevitable bad loans are already turning up. Yet the markets are not unduly concerned. While other countries suffer the ill consequences of reckless lending, China’s fate is different. Or, so we are told.
In 2009 and 2010, total credit grew respectively by 39 per cent and 34 per cent of GDP. At 160 per cent of GDP, China’s stock of debt has climbed by 40 percentage points since early 2009. In a recent report, Credit Suisse economist Vincent Chan observes that Chinese credit growth has reached the critical level that has previously anticipated sudden downturns in other countries.* Non-bank credit instruments are also proliferating in China. A shift to this type of short-term funding is a typical indicator of rising financial fragility.
Problems are appearing with loans to local government infrastructure projects, which constitute the bulk of the recent credit surge. Last month, a heavily indebted toll road operator in the south-western province of Yunnan announced it could not meet its repayment schedule. A port operator in Shanghai was reported to have illegally diverted working capital loans into real estate investments. Beijing’s Land Reserve, a levered vehicle that is used to fund public land purchases, apparently faces liquidity problems.
Nobody knows for sure how much debt these local government funding vehicles have taken on. The highest reported figure of Rmb14,000bn ($2,165bn) exceeds one-third of China’s GDP. Nobody knows how many of these loans will default. Moody’s has warned they may drive the banks’ non-performing loan ratio to 12 per cent. In any other country, this would be a cause for concern. But not in China. Stephen Roach, a former chairman of Morgan Stanley’s Asian operations, typifies the prevailing sang-froid: “it doesn’t pay,” writes Mr Roach, “to diagnose the Chinese economy by drawing inferences from the experiences of others”.
After all, China has experience with bad debts. At the turn of the century around 40 per cent of Chinese bank loans were non-performing. Yet this mountain of bad loans did not portend an economic slowdown, undermine public finances or derail economic growth. In fact, over the following decade, China’s economy expanded rapidly. Its banks were cleaned up, listed on the world’s stock exchanges, and are today ranked among the world’s most valuable companies.
The story of how Beijing dealt with these bad debts is told in the book Red Capitalism by Carl Walter and Fraser Howie. Non-performing loans were taken from the banks at face value and handed over to government-controlled asset management companies, which in turn issued notes that were acquired by the same banks. The central bank indirectly used foreign exchange reserves to provide banks with new equity. Some bad loans were guaranteed by the Ministry of Finance and remained on the banks’ balance sheets as “restructuring receivables”.
By such acts of, what Mr Walter and Mr Howie aptly term, “financial legerdemain” China was able over a number of years to absorb bad debts equivalent to around a quarter of GDP. Depositors also contributed to the recapitalisation of the banking system. Deposit rates were kept artificially low, thus boosting the banks’ lending margins. Robust economic expansion did the rest.
Most commentators believe that the non-performing loans generated by the recent credit boom will be handled with similar aplomb. Yet circumstances have changed. China’s credit system is more transparent than a decade ago. This could make Beijing’s financial boot-strapping more problematic. Bank depositors may also try to avoid footing the bill. Despite capital controls, it is increasingly easy for rich Chinese to move money offshore. The proliferation of high-yielding financial products provides an alternative to bank deposits for savers.
A decade ago, China’s economy had been restructured and enjoyed the benefits from accession to the World Trade Organisation. Exports and foreign direct investment were surging. The economy was spurred by a continuous flow of urban migrants and rising levels of fixed asset investment. These sources of growth have largely been expended. China can no longer expand its share of global trade without antagonising trading partners; migration from rural areas is slowing; and fixed asset investment at close to 50 per cent of GDP is far too high. The economy is also vulnerable to a collapse of the property bubble.
The Chinese authorities engineered a credit boom in 2009, believing they could sweep the resulting bad loans under the carpet as they had done in the past. But both China’s economy and debts are far larger today. It will be a challenge to pull off the same trick again.
* Vincent Chan, Debt Threats – Rising, Credit Suisse, 20 June 2011
Edward Chancellor is a member of the asset allocation team at investment manager GMO
Insight China’s old bad banks run new risks
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Doubts deepen over Chinese banks
China Price Watchers Predict Another Peak
By AARON BACK And JASON DEAN
BEIJING—Economists are predicting that China's surging inflation—reflected in new data showing a sharp rise last month—is about to hit its peak and start subsiding, which could augur a halt to the government's efforts to tap the breaks on the world's No. 2 economy. But many of those same economists were predicting exactly the same thing a year ago.
China's National Bureau of Statistics on Saturday said that the consumer price index in June surged by 6.4% from a year earlier. That was a jump from May's 5.5% rate and close to the high hit three years ago.
"Most economists (including us) believe CPI inflation could peak in June and decline" in the second half of 2011, Lu Ting, China economist at Bank of America Merrill Lynch, said in a note last week. Indeed, a Dow Jones Newswires survey of 13 economists on Thursday, following the People's Bank of China's fifth interest-rate increase in eight months, found that eight of them don't expect any further increases the rest of this year.
Rewind 12 months, when consumer prices were rising around 3%, and the message was similar. The headline inflation reading "is likely to rise again in July due to rising food prices," Mr. Lu wrote on July 15, 2010, "but it's very likely that it will just peak in July...and then will trend down on a rising comparison base."
He was hardly alone. Almost all major economists at international banks, research houses and agencies missed the mark. Although "inflation continued to accelerate, we believe underlying inflationary pressures are dissipating quickly," wrote Yu Song of Goldman Sachs in June 2010. "Inflation might have risen again last month but the peak is probably not far away," said Mark Williams of Capital Economics on July 8 of that year. "Barring an unforeseen supply shock to food prices, consumer-price inflation should peak in midyear and begin falling in the second half of 2010," wrote economists at the International Monetary Fund in a report that month.
In fact, inflation jumped to 5.1% in November, stayed high for months, and is now climbing again.
For investors, executives and others around the world trying to guess where China's economy is headed now, understanding why analysts got it wrong last summer can help to gauge how much confidence should be placed in the current forecasts.
Predicting prices and other factors is always tricky, especially in an economy as large and complicated as China's, where there is limited transparency in the official data. And bucking the consensus is always difficult for analysts.
Chinese leaders have been among those underestimating inflation: The average CPI surpassed the government 3% full-year target for 2010, and Premier Wen Jiabao last month acknowledged it will likely exceed this year's target of 4%, too. The influence of government pronouncements on forecasts can be pernicious in China, because they are often seen as reflecting inside information.
"Forecasting inflation is always much more difficult than forecasting growth," says Merrill's Mr. Lu. "So take all these inflation forecasts with a grain of salt. This is something where we should all be humble, especially for forecasting a specific point in time for peaking or bottoming."
An examination of the past predictions suggests several reasons that analysts were caught by surprise.
For one, they underestimated the role played by the explosion of cash in the economy resulting from government-driven stimulus spending in 2009 and 2010 aimed at fending off the global recession. China's total stock of outstanding bank loans rose by nearly two-thirds during that two-year period, a deluge of credit that sent money sloshing around the economy, putting cash in consumer pockets and eventually driving up the prices for everyday goods.
"I guess you could say that the persistence of inflation has lent credence" to the view that surging money supply has driven inflation, says Mr. Williams of Capital Economics in London. "I still struggle with that, though, because when you look at where the inflation is coming from, it's still pretty much about food, and specific foods as well, and I still struggle to see how increasing loans to state-owned firms pops up a few minutes later in cabbage prices."
Indeed, food prices have been perhaps the biggest driver of China's inflation, rising 14.4% in June. Food prices are inherently volatile, depending on unpredictable factors like weather conditions.
Floods and droughts occur almost every year in China, and in such a huge country with a largely underdeveloped agricultural sector, those factors can cause significant temporary disruptions. Floods were behind a surge in vegetable prices last year, and drought conditions in wheat-growing areas pushed up wheat prices early this year.
"The key problem in forecasting CPI in China is that food has been responsible for about two-thirds of the overall CPI rise, and food prices are notoriously difficult to predict," says Andy Rothman, China macro strategist at CLSA Asia-Pacific Markets.
Adds Wang Tao, China economist at UBS: "I am only an economist and could not forecast weather and natural disasters."
Despite their earlier missed calls, economists remain confident that inflation is set to slow in the second half of the year. Money-supply growth has slowed considerably in response to tightening measures by the central bank. Forecasters also expect a recent surge in pork prices that has driven up the CPI to be temporary, as farmers respond by breeding more pigs.
A high inflation rate late last year also means China's inflation rates will appear lower in coming months when compared against the year-earlier period, which is how inflation in measured in China. For that reason, it will be much more important to look at how prices relate to the previous month, rather than a year ago.
But wholly unpredictable factors, such as bad weather, could once again intervene. Given the regularity with which such shocks occur here, forecasters shouldn't count on trouble-free farming from June onward.
At the end of the day, economists acknowledge that inflation forecasting in China is imprecise. Says Mr. Williams: "Although we are still expecting inflation to come down, the confidence with which we hold that view is probably lower than it was a few weeks ago."
—Tom Orlik contributed to this article.
Whether how much the debt has, to our happy and lucky, our government has the confidence to face the plight by the discretional monetory policy and positive fiscal polisy. Decades ago ,we joined in the WTO, held the Olympic Games successfully, defeated virious disasters such as the flood ,earthquake and so forth. What's more, we can suvive ,however ,other countries are deeply fallen into the finacial crisis. In my opinion , we have the most amout porpulation of the world, and now we walk into the knowledge-based economy era, person as the carrier of the knowledge will stand on the historical stage. That will be the core competitive strengths for the world competive. I believe our country can survive and defeated the turbulance !
这个问题的确应该值得官方和学者思考Problems are appearing with loans to local government infrastructure projects, which constitute the bulk of the recent credit surge. Last month, a heavily indebted toll road operator in the south-western province of Yunnan announced it could not meet its repayment schedule. A port operator in Shanghai was reported to have illegally diverted working capital loans into real estate investments. Beijing’s Land Reserve, a levered vehicle that is used to fund public land purchases, apparently faces liquidity problems.
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