IMF Again Warns China Off Growth For Growth’s Sake

THE IMF’S NEWLY published World Economic Outlook projects a 0.1 percentage point increase in GDP growth this year over last, to 6.8%. That is an upward revision of 0.1 percentage point to its July forecast, based on policy easing and stimulus to domestic demand earlier in the year.

However, the Fund sees the glide path of managed slowing growth resuming next year, with GDP growth forecast at 6.5% in 2018 (again up 0.1 percentage point from July’s forecast, and up 0.2 percentage points from its April forecast) and thereafter slowing further to 5.8% by 2022.

By that point, the IMF expects China to be growing more slowly than the emerging and developing Asia average, forecast at 6.3%. That would a phenomenon not seen since China started its double-digit growth spurt.

That, in its way, would be a mark of success for the rebalancing of the economy towards being more consumption-driven and less dependent for growth on infrastructure investment and exports. The IMF is projecting that China’s current account balance will have shrunk to $28.8 billion by 2022, against $196.4 billion last year, and almost one-tenth of the level it was a decade ago. As a percentage of GDP, the effect will be even more dramatic: a projected 0.2% in 2022 against 4.7% in 2009.

All neat projections, but realizing them is not without risk, most notably in managing debt:

Over the medium term, dealing with financial sector challenges will be essential. Minimizing the risk of a sharp slowdown in China will require the Chinese authorities to intensify their efforts to rein in the credit expansion.

The conundrum is that 6%-plus growth is necessary for China to have met its target of doubling real GDP between 2010 and 2020. To make sure it does, Beijing will be in no hurry to withdraw its stimulus.

However, as this Bystander and others have noted before, delay comes at the cost of further increases in debt, making the issue more difficult to resolve through the necessary measures of tighter supervision, reined-in expansion of credit and writes down of the underlying stock of bad assets.

This, in turn, would slow rebalancing and reduce the policy space available to respond in case of an abrupt shock to the system, internal or external.

Such shocks are not difficult to imagine, and are detailed by the Fund:

a funding shock in the short-term interbank market or the funding market for wealth-management products; the imposition of trade barriers by trading partners; or a return of capital outflow pressures because of a faster-than-expected normalisation of US interest rates.

The political dimension to this, unaddressed by the IMF, not surprisingly given its sensitivity, is whether President Xi Jinping will emerge from next week’s Party Congress in a sufficiently strong position to be able deemphasize near-term growth targets and implement more reforms that would enhance the sustainability of growth. Without doing so, he will be unable achieve his long-term goal of maintaining the Party’s monopoly grip on power while transforming China’s economy to its next phase of development.

China’s Banks Accelerate Bad-Loan Write-Offs

THE BOND DEFAULTS and bank runs seen in recent weeks are small beer when it comes to signs of stress faults in China’s financial system. Far more concerning is the rapidly rising volumes of loans turned sour that the country’s big banks have been writing off.

China’s five biggest banks — which account for more than half of all loans written — wrote off 59 billion yuan ($9.5 billion) of bad debt, according to their 2013 results, the Financial Times reports. That was up 127% from the previous year’s write-offs and the most since the big-state-owed banks had to be cleaned up and recapitalized a decade or so back. A slowing economy and authorities efforts to reign in shadow banking are making it more arduous for borrowers to repay debt.

The big banks have been required by authorities to build up a plump cushion of reserves to absorb bad loans such as these, and to absorb those that offer any hint of defaults that pose the remotest systemic risk. One of the benefits of the measured pace of financial reform is that the big bank’s profits, though growing more slowly than previously, remain healthy despite having to hold higher capital reserves.

The banks’ reported ratio of bad loans to total loans remains a comfortable looking 1% for last year, up from 0.95% in 2012. That prompts two questions: first, to what extent are write-offs being used to massage that number; and second, how accurate are the banks’ reported non-performing loans numbers? Some suggest the true number could be five times as large.

As the credit rating agency, Standard & Poor’s, recently noted, loan quality will likely decline further in 2014. Banks remain at risk from debt-laden local government financing vehicles, a weakening real estate market, and earnings-challenged manufacturers for whom a slowing economy is only exacerbates the ill-effects of the excess capacity they borrowed to build. And if the leadership holds to accepting slower growth as one of the cost of economic reform to rebalance the economy, these strains on the financial system are likely to continue well into 2015, too.

China Said Set For Big Boost To Muni-Bond Market

China looks set to give a big boost to its nascent muni-bond market this year. The Finance Ministry is to quintuple the quota for local government bond issuance to 250 billion yuan ($40 billion) this year, Caixin reports.

In addition, more provinces will reportedly be added to the list of those able to issue bonds directly. Since 1994, the ministry has done that on behalf of local governments but started an experiment in direct issuance in October last year with Shanghai, Shenzhen, Guangdong and Zhejiang. That privilege will be extended to six more provinces and municipalities. The ministry is expected to maintain the close control over the bond issuance by the larger group that it has exercised over the trial quartet, including having a big say over what the funds raised can be used for.

Expanding the muni-bond market is both part of the broader reforms of the financial system and local government finances. The latter are teetering under the burden of 10.7 trillion yuan of debt, at least 3 trillion yuan of which falls due by the end of this year. Much of the debt piled up as a result of the stimulus spending in the wake of the 2008 global financial crisis. Much of it is infrastructure loans, for things like toll roads to nowhere, that are weighing heavily on the creditworthiness of China’s banks.

Earlier this month the China Banking Regulatory Commission ordered banks to clean up their balance sheets with regard to local government lending. It first told them to do that in June last year, but progress clearly hasn’t been rapid enough, or, as a result of the cooling of both the economy and the property market, problem loans are mounting. Good and bad loans alike were probably rolled over when banks tackled the 2 trillion yuan of local government loans that fell due last year. Another red flag raised by China’s audit office: irregularities it has found with 530 billion yuan worth of the lending. Taken together, an estimated 2 trillion-3 trillion yuan of local government lending has soured, which would be sufficient to raise the banks’ non-performing loan ratios to 5% from their current average of 1.1%.

The new quota of 250 billion yuan for bond issuance won’t wipe away the problem but every little bit helps–though places like Greece serve as a reminder that bond issuance is not an infallible inoculation against the highly contagious disease of government fiscal profligacy. Yet while the immediate priority is to deflate China’s local-government debt bubble before it can go damagingly pop, an expanded muni-bond market also pushes provincial and municipal governments in three other desirable directions: less reliance of land sales to raise revenue, less need for the off-balance sheet financing via captive investment vehicles that local authorities have resorted to get round restrictions on official borrowings, and more transparency generally about their finances.