Tag Archives: monetary policy

China’s State-Owned Debt Problem

WHEN, AS IS expected later this year, the U.S. Federal Reserve starts to raise interest rates, it will put renewed strain on emerging economies’ debt management. Those most vulnerable are countries with high levels of dollar-denominated external debt and those with high public debt.

Where does that leave China? As so often, slightly oddly placed.

China’s external debt exposure is low. Foreign debt is estimated to be equivalent to less than 10% of GDP. That modest figure by international standards is because China funded its infrastructure building domestically and not by borrowing from abroad. Thus it has avoided one of the textbook potential triggers of an emerging market debt crisis. It helps that China has a financial system that is semi-detached from global capital markets.

On the other hand, China’s domestic borrowing is huge. Total debt, including debt of the financial sector, nearly quadrupled between 2007 and 2014, by the reckoning of the McKinsey Global Institute (MGI), rising from $7.4 trillion to $28.2 trillion, or from 158% of GDP to 282%. This increase was a consequence of the investment-driven stimulus Beijing launched to offset the 2008 global financial crisis and which was funded by bank credit, albeit domestic not external borrowing.

That new debt was largely taken on by non-financial corporations. MGI calculates that that set’s debt accounts for 125% of GDP. Rating agency Standard & Poor’s estimates that China surpassed the United States as the largest corporate debt borrower in 2013.

China’s non-financial corporations are a broad church, however. Their debt is concentrated within state-owned enterprises, not anymore in private companies with the one significant exception of firms in the property sector. MGI estimates that approaching half of non-financial corporate debt connects in some way to real estate development, with 60 firms accounting for two-thirds of it.

An IMF Working Paper on corporate indebtedness in China published by Mali Chivakul and W. Raphael Lam in March puts it thus, “while leverage on average is not high, there is a fat tail of highly leveraged firms accounting for a significant share of total corporate debt, mainly concentrated in the real estate and construction sector and state-owned enterprises in general.”

Chivakul and Lam go on to argue that development and construction firms could withstand a modest interest rate shock, but other corporations in the wider economy would feel the knock-on effect of a slowdown in the property sector. “The share of debt that would be in financial distress would rise to about a quarter of total listed-firm debt in the event of a 20% decline in real estate and construction profits,” they say.

A separate report from economists at the Hong Kong Monetary Authority comes up with a similar analysis — that China’s debt problem is largely an SEO debt problem — and points the finger at  ‘policy driven lending’. “SOEs’ leveraging has been mainly driven by implicit government support amid lower funding costs than private enterprises,” they say.

There is now less such politically driven new lending than before. That partly reflects the passing of the post-2008 stimulus but also a recognition that private firms create the new jobs that are critical to social stability. It also reflects the shuttering, particularly since 2012, of small, inefficient and heavily polluting and indebted SOEs in industries such as steel, cement and mining.

A further round of such ‘SOE reform’ seems likely. And to this Bystander, the corruption investigations into SOEs seems in part an attempt to accelerate those reforms, given that  SEOs are seen as acting as a drag on the wider push for reform and economic rebalancing.

From SOEs it is but a short step to China’s other deep pool of domestic-debt concern — local government borrowing. Outstanding debt has reportedly reached 16 trillion yuan ($2.6 trillion), up 47% from June 2013. Overall, government debt is equivalent to 55% of GDP, again not a concerning high level by international standards. But it is concentrated in pockets, closely tied to real estate, and a further drag on an already slowing economy.

Beijing has both the political will and the financial wherewithal to underwrite local government defaults and forestall any threat of financial systemic risk. However, policy makers will use the mere hint of it to push local government finance reform and deepening municipal bond markets.

Local governments have relied on land sales for revenue, and also seek to turn a yuan from commercial activities conducted through captive off-balance-sheet special financing vehicles, which have borrowed heavily from both mainstream and shadow banks. So the threat of contaigion is real. Rising interest rates will only make it more so, and aid the cause of local government finance reform.

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China Adds More Speed Bumps To The Road To Rebalancing

THE PEOPLE’S BANK of China has reportedly injected some 500 billion yuan into the five biggest commercial banks in the form of short-term low-interest loans. This can best be regarded as a targeted monetary easing to perk up an economy at risk of falling short of its official target of 7.5% annual growth following a run of soft monthly economic indicators. Four months of a weakening property market, in particular, has culminated in noticeable economic sluggishness since mid-August.

Taking such action ahead of the October national day holiday, during which the banks traditionally face high cash withdrawals, gives the central bank a fig leaf from behind which to claim, should it be of a mind to explain its motives, that it is not indulging in old-school stimulus. Much of the new loans is likely to end up in the real estate sector and funding new infrastructure, however, and thus lay down more speed bumps along the road to rebalancing the economy.

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China’s Second-Quarter GDP Growth Exceeds Expectations

CHINA’S SECOND-QUARTER growth came in at a slightly better-than-expected 7.5%. That is 0.1 percentage points up on the first quarter. Thank a series of targeted stimulus measures for that. Both retail sales and industrial production rose in the quarter.

With the stimulus effects likely to carry over to the third quarter, the official target of 7.5% GDP growth for the full year is back on track. Additional stimulus is unlikely for now except in the slowest growing provinces, where local authorities are still spending heavily, old school.

Low inflation leaves Beijing with some monetary policy flexibility, but cutting interest rates or banks’ reserve requirements to help business get more credit has to be balanced against reigniting asset prices, particularly property.

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China’s Slowing Manufacturing Activity Tests Policymakers’ Resolve

So far China’s new leadership has resisted short-term fixes to the country’s slower growth and held true to the need for deeper structural reforms to rebalance the economy. The latest measure of economic activity — HSBC’s flash purchasing managers’ index for May — may test their resolve, but not, this Bystander hazards, break it.

The May reading, at 49.6, down from April’s 50.4, was the lowest in seven months. More germanely, it fell below the 50 mark that delineates expansion from contraction. The modest expansion of manufacturing activity that has been seen since the slowing economy started to pick up steam again last autumn has been replaced by modest contraction. The second area of concern is that the weakness seen by China’s manufacturers in global demand for their goods and services seems to have spread to their domestic customers.

The difficulty for policymakers is that they have limited scope even for short-term fixes. Monetary policy is already easy and loosening it further or splashing out on another round of government funded infrastructure investment spending risks further inflating property bubbles and an already concerning local government debt overhang. At best there is likely to be spot stimulus measures applied where local employment conditions put social stability at risk.

One of the vehicles for this might be the new leadership’s urbanization plans, a centerpiece of its long-term management of moving China to a slower growth trajectory than the double digit annual growth it averaged over the past three decades. While the plan will take years to implement, it could set a tone for structural reform that would have a more immediate effect on economic confidence, and prevent GDP growth for the year falling below 2012’s 7.8%, its slowest in more than a decade.

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Fragile Industrial Output Tests China’s Policymakers’ Nerve

Economic activity remains weak in China. April’s industrial output was up 9.3% in April from March’s 8.9%, a seven-month low, but short of expectations of 9.5% growth. The recovery that started in the second half of last year is not gathering any momentum. Second-quarter growth is on track to be little better than the first quarter’s 7.7%, and likely less than 8%.

That is testing policymakers’ patience. They would like to stimulate short-term growth, but are already  running loose monetary policy. Any further loosening risks pushing up consumer prices and further inflating asset bubbles, particularly property prices. Meanwhile, state-led infrastructure construction spending, which has been a big driver of growth since the 2008 global financial crisis, is running out of steam and effectiveness, and the debt overhang, as much as 20 trillion yuan ($3.25 trillion), is a worry in Beijing.

The temptation, particularly for provincial and local officials, is to fall back on the tried and trusted remedy to provide a short-term boost to growth, but that also delays the necessary long-term rebalancing of the economy to which the new leadership repeatedly says it is committed. For now, policy makers are likely to stay their course, but they badly need some growth to steady their nerves. With the global economy sluggish, that is more out of their hands than they would like.

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China’s Recovery Stutters In First Quarter

China’s economy grew more slowly in the first quarter of this year than it did in the fourth quarter of last — 7.7% year on year against 7.9%. The consensus among economists had been that the recovery from last year’s slowdown would continue into the first quarter, albeit modestly, but not ease back.

It was industrial production that was the weak spot. Fixed asset and real estate investment both ran at 20% above the same quarter the previous year. Absent the weakness in industrial output, that might have tempted policy makers to tighten monetary policy to cool off the property market. This Bystander would now expect the central bank to hold fire on that while it sees if the recovery picks up again in the second quarter.

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China’s Economic Rebound Will Carry Into 2013’s First Quarter

This Bystander is not as surprised as some to see the December HSBC Purchasing Managers’ Index for December showing further expansion of China’s economy. Infrastructure spending and cautiously easier monetary policy have been visibly kicking in since September.

The final reading of the December HSBC PMI was 51.5, compared to a preliminary reading mid-month of 50.9 and November’s 50.5. A reading above 50 indicates expansion. Domestic demand is making up for sluggish overseas markets; the new export orders sub-index for December fell to 49.2 from November’s 52.1. That manufacturing is growing at its fastest pace since May 2011–and the official PMI due tomorrow will tell much the same story–will give policymakers in Beijing good reason to believe that the momentum of an accelerating pace of expansion can be carried into 2013.

How far and how fast will they let it run? The People’s Bank of China on Saturday flagged the risk of defaults in the shadow banking system. Inflation, a persistent concern, is beginning to edge up again. If either concern is present beyond the first quarter of 2013, some tightening is likely to start.

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