{"id":1968,"date":"2013-06-11T13:58:56","date_gmt":"2013-06-11T08:28:56","guid":{"rendered":"http:\/\/teekhapan.wordpress.com\/?p=1968"},"modified":"2013-06-11T13:58:56","modified_gmt":"2013-06-11T08:28:56","slug":"is-china-getting-ready-for-the-next-big-financial-crisis","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2013\/06\/11\/is-china-getting-ready-for-the-next-big-financial-crisis\/","title":{"rendered":"Is China getting ready for the next big financial crisis?"},"content":{"rendered":"

 
\n
\n\"the-up-of-the-great-wall\"<\/a><\/span><\/span><\/span>\u00a0<\/span>
\nVivek Kaul
\nA famous Central Intelligence Agency (CIA) paper on China is titled \u201c<\/span><\/span><\/span>The Art of China Watching<\/span><\/span><\/span><\/span><\/a>\u201d. In this paper the author Gail Solin concedes that \u201cThe art of China-watching is imprecise at best…The explanation, or blame, for this often frustratingly lies mainly with the way the Chinese conduct their affairs. To say the Chinese have a penchant for secrecy is almost an understatement.\u201d
\nEdward Chancellor and Mike Monnelly of the global investment management firm GMO writing in a white paper titled\u00a0<\/span><\/span><\/span>Feeding the Dragon: Why China\u2019s Credit System Looks Vulnerable<\/span><\/i><\/span><\/span><\/span><\/a>suggest that the CIA paper was written sometime in the 1970s.
\nWhen it comes to those from the outside watching the Chinese financial system, things haven’t changed nearly four decades later. China watching is still imprecise at best. Or as Stephen Green, head of Greater China research\u00a0<\/span><\/span><\/span>at Standard Chartered Plc in Hong Kong recently told Bloomberg<\/span><\/span><\/span><\/span><\/a>\u00a0\u201cIt\u2019s a big black box, and it\u2019s quite scary.\u201d
\nAnd a few things coming out of the black box now seem to suggest that things are not as hunky dory as they are being made out to be. The loans given by banks and other financial institutions have reached very high levels. As Chancellor and Monnelly point out in their research paper \u201cBetween 2007 and 2012, the ratio of credit(i.e. loans) to GDP climbed to more than 190%, an increase of 60 percentage points. China\u2019s recent expansion of credit relative to GDP is considerably larger than the credit booms experienced by either Japan in the late 1980s or the United States in the years before the Lehman bust.\u201d As of the end of 2012, the total lending by banks and other financial institutions as a proportion of the GDP ratio stood at 198%.
\nSo China has a debt problem, given that the total loans given by its banks and other financial institutions have risen at a very rapid rate. \u201cThere is just no way to grow out of a debt problem when credit is already twice as large as GDP and growing nearly twice as fast<\/span><\/span><\/span>,<\/i><\/span><\/span><\/span>\u201d Charlene Chu Senior Director in the Financial Institutions Group at Fitch Ratings based out of Beijing, told Bloomberg.
\nWhat is interesting is that the loan boom in China has been faster than many other countries which have faced severe banking and financial crises in the past. As the Bloomberg story points out \u201cA jump in the ratio of credit to GDP preceded banking crises in Japan, where the measure surged 45 percentage points from 1985 to 1990, and South Korea, where it gained 47 percentage points from 1994 to 1998, Fitch said in July 2011. In China, it has increased 73 percentage points in four years, according to Fitch\u2019s estimates.\u201d
\nAnd this loan growth continues unabated. In the period January-March 2013 total loans grew by 20% in comparison to the same period last year. There are two main problems that arise with excessive loan growth.
\nAs Wei Yao of Societe Generale writes in a report titled\u00a0<\/span><\/span><\/span>China\u2019s missing money and the Minsky moment\u00a0<\/i><\/span><\/span><\/span>\u201ca fast rising debt load of an economy suggests either deteriorating growth efficiency or high and rising debt service cost, or in many cases both. There is clear evidence that China is suffering from both of these.\u201d
\nWhat this means is that China now needs more and more debt to create the same unit of growth. Meanwhile the debt service ratio keeps growing. Debt service ratio is essentially the sum of interest to be paid on all the outstanding loans along with the maturing loans that need to be repaid expressed as a percentage of GDP. Wei Yao estimates that China has \u201ca shockingly high debt service ratio of 29.9% of GDP, of which 11.1% goes to interest payment and the rest principal.\u201d
\n\u201cAt such a level, no wonder that credit growth is accelerating without contributing much to real growth!,\u201d she writes.
\nA lot of the excessive loan growth in China has gone into buying and building property, where no one lives. \u201cMiles upon\u00a0miles of half-completed apartment blocks encircle many cities across the country. Official data suggest that the value of the unfinished housing stock is equivalent to 20% of GDP and rising..Developments in the infamous \u201cghost city\u201d of Ordos, in Inner Mongolia, reveal the vulnerability of China\u2019s credit\u00a0system to an overblown housing market. The Kangbashi district of Ordos is a totem for China\u2019s property excesses. Kangbashi has enough apartments to shelter a million persons, roughly four times its current population,\u201d write the GMO authors.
\nThis basically means that builders who built these homes are not in a position to repay the loans they had taken on, given that the homes are not selling and have been more or less abandoned. This excessive building of homes was driven primarily by demand from speculators. The government has taken various steps to kill ‘speculation’ from time to time but hasn’t done enough and it keeps coming back.
\nAndy Xie, a former Morgan Stanley analyst, who closely tracks China made a fairly interesting point\u00a0<\/span><\/span><\/span>in a column he wrote in late March 2013<\/span><\/span><\/span><\/span><\/a>. As he wrote \u201cThe government has introduced tightening measures against property speculation from time to time. These measures have never been serious enough to stamp out speculation. They merely slowed and extended it. The ineffectiveness of the measures keeps up the dream that prices could surge when the government either loosens up or is overwhelmed. That dream keeps speculators in the game. The latest measure \u2013 a 20 percent capital gains tax, yet to be fleshed out in detail \u2013 is the latest example. In the short term it sparked a frenzy because speculators are rushing to buy before the tax comes into effect.\u201d
\nThis has led to a situation where banks and other financial institutions have ended with a lot of real estate as a collateral against the loans they have given out. \u201cIt\u2019s probably fair to say that at least one-third of bank credit exposures are real estate related,\u201d write Chancellor and Monnelly.
\nBanks have also given a huge amount of loans to local governments and taken on land as a collateral. The trouble is that a lot of this land has been dubiously overvalued by local governments to take on higher amount of loans. \u201cThe quality of the collateral held by the banks against their loans has\u00a0been questioned. Collateral often comes in the form of land, which in some cases has been valued by local officials at a premium to actual market values…Loudi, a little-known city in Hunan province, serves as the poster child for local government funding vehicles excesses. According to Bloomberg,\u00a0Loudi\u2019s local government borrowed RMB 1.2 billion to finance the construction of a 30,000-seat faux Olympic stadium, gymnasium, and swimming complex. The land collateral for Loudi\u2019s loan was valued at around four times the value of nearby plots zoned for commercial use,\u201d Chancellor and Monnelly point out. So if the banks try to sell the land they have as collateral in case of defaults, they are not going to recover a large portion of the loans they have made.
\nAlso, a lot of local governments have taken on a large amount of loans to spend on trophy projects which are not going to generate returns any time soon. One such project is the famous maglev (magnetic levitation) train that goes from Longyan Road in Shanghai to Pudong International Airport in eight minutes.
\nRuchir Sharma,\u00a0head of Emerging Markets and Global Macro at Morgan Stanley Investment Management,\u00a0describes his experience of taking the train in\u00a0<\/span><\/span><\/span>Breakout Nations.\u00a0<\/i><\/span><\/span><\/span>While the experience was fantastic, there were hardly any passengers around. He points out that locals say that the train is usually only half full because it starts in the middle of nowhere and the ticket is very expensively priced.
\nSuch projects are not expected to generate returns anytime soon, making the repayment of loans even more difficult. As Chu of Fitch told Bloomberg \u201cCompanies are taking on a lot of debt but not getting comparable returns… If they\u2019re not getting sufficient returns, at some point they will have problems repaying the debt.\u201d
\nSo the situation is tight but this hasn’t started reflecting in loans defaults as yet. The formal banking system has a non performing loan ratio of around 1%. There are several reasons why this ratio is not higher. One simple reason is that the banks have been allowed to roll-over loans, in case the local government bodies which have taken on the loans are not able to pay up. This basically means that when a loan falls due and the borrower needs to repay it, the bank does not demand repayment of the loan and continues to accept interest on it from the borrower.
\nWhat has also happened is that banks are selling bonds bundled into wealth management products to their clients. These bonds are supposed to be raising money to finance infrastructure projects. But that is really not the case. As the GMO authors write \u201cCaixin (a Beijing based media group) quotes a source at a major bank claiming that many bonds, which purported to finance new infrastructure projects, were actually being used to pay off old bank debts. While this has allowed banks to reduce their reported exposure to local governments, it is possible they will have to make good any future losses suffered by investors on future bond defaults.\u201d So basically future bad loans of banks have been passed onto bond investors.
\nOf course such things cannot go for eternity. As Wei Hao of Societe Generale puts it \u201ca number of economies had similar or moderately lower debt service ratios (DSRs) when they were headed towards serious financial and economic crises. Examples include Finland (early 1990s), Korea (1997), the UK (2009), and the US (2009). This is one more data point in China that evokes the troubling thought of a hard landing.\u201d
\nBut not everyone is willing to buy this argument. Those who don’t buy feel that China is in the midst of a ‘credit bubble’ like to point out that most of the outstanding Chinese debt is domestic. And given that there can be no crisis. They just need to look at Japan. Domestic savings fuelled a stock market and real estate bubble in the late 1980s. The bubble started to burst in 1989, and the Japanese economy has never recovered since then.
\nThe other point that China supporters like to point out is that China has a very low government debt to GDP ratio. As Chancellor and Monnelly point out \u201cMany commentators also take comfort from the fact that China\u2019s public debt (another term of government debt) is less than 30% of GDP. The trouble\u00a0is that the official numbers are misleading…In order to get a proper picture of China\u2019s sovereign liabilities we must add back the loans to local government infrastructure projects, policy bank debt (issued by the likes of the China Development Bank), borrowings by the asset management companies (which acquire non-performing loans from banks and others), and debt issued by the Ministry of Railways to fund the roll-out of the expensive high-speed rail network.\u201d After this is done, China’s government debt to GDP ratio comes close to 90%, which is not small by any stretch of imagination.
\nSo while there might be many out there who would like to believe that all is well in China, the evidence is clearly to the contrary. Chu of Fitch put it best when she told Bloomberg \u201cYou just don\u2019t see that magnitude of increase in the ratio of credit to GDP…It\u2019s usually one of the most reliable predictors for a financial crisis.\u201d
\nThe article <\/a>originally appeared on www.firstpost.com on June 11, 2013<\/span><\/span><\/span>
\n(Vivek Kaul is a writer. He tweets @kaul_vivek)\u00a0<\/b><\/i><\/span><\/span><\/span>
\n\u00a0<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

  \u00a0 Vivek Kaul A famous Central Intelligence Agency (CIA) paper on China is titled \u201cThe Art of China Watching\u201d. In this paper the author Gail Solin concedes that \u201cThe art of China-watching is imprecise at best…The explanation, or blame, for this often frustratingly lies mainly with the way the Chinese conduct their affairs. To … <\/p>\n

Read more<\/a><\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"qubely_global_settings":"","qubely_interactions":"","_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"jetpack_post_was_ever_published":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[2,31,33],"tags":[425,682,2994],"qubely_featured_image_url":null,"qubely_author":{"display_name":"Vivek Kaul","author_link":"https:\/\/vivekkaul.com\/author\/vivekkaul\/"},"qubely_comment":0,"qubely_category":"Analysis<\/a> Financial Crisis<\/a> Firstpost<\/a>","qubely_excerpt":"  \u00a0 Vivek Kaul A famous Central Intelligence Agency (CIA) paper on China is titled \u201cThe Art of China Watching\u201d. In this paper the author Gail Solin concedes that \u201cThe art of China-watching is imprecise at best…The explanation, or blame, for this often frustratingly lies mainly with the way the Chinese conduct their affairs. To…","jetpack_sharing_enabled":true,"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/posts\/1968"}],"collection":[{"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/comments?post=1968"}],"version-history":[{"count":0,"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/posts\/1968\/revisions"}],"wp:attachment":[{"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/media?parent=1968"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/categories?post=1968"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/vivekkaul.com\/wp-json\/wp\/v2\/tags?post=1968"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}