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Summary
While China largely avoided the subprime mess, spillover from the ongoing financial
crisis in the West’s more developed economies has taken its toll on China’s export
sector. Beijing has been implementing massive fiscal stimulus and encouraged a new
lending spree that has averaged over a trillion yuan ($146.5 billion) per month in the first
nine months of this year. However, while the pace and magnitude of this lending has
stoked fears that China may be laying the groundwork for an imminent banking crisis of
its own, China could potentially delay the day of reckoning for some time to come.
Analysis
With the onset of the global financial crisis in the 4th quarter of 2008, it became very
clear that new orders for Chinese goods were to slow dramatically and that this would
pressure exports, which account for 40 percent of China’s GDP. Due to its the perennial
concerns for unemployment and civil unrest, however, Beijing could not allow Chinese
firms to respond to the slump in external demand by reducing production or cutting staff.
Therefore, to counterbalance the external slowdown, Beijing embarked upon a twopronged strategy aimed at (1) creating demand for China’s “exports” by increasing fiscal
expenditure for large infrastructure projects, and (2) encouraging banks, especially stateowned banks, to increase lending to corporations and state-owned enterprises so as to
help them finance their way through the worst of the downturn.
China was able to implement its plan quickly and effectively. Beijing’s 4 trillion RMB
stimulus plan was implemented last November shortly after the crash of Lehman
brothers, while Banks’ increased lending began in earnest in January of 2009 when net
new loans increased by 732 billion RMB. However, the second part of China’s plan has
been, many say, too successful— the increased lending has simply not stopped and is
not threatening to do more harm than good.
The Loan Surge
In the first nine months of 2009, Chinese financial institutions’ posted a net increase in
new loans of 9.38 trillion RMB— an average monthly increase of over 1 trillion RMB.
This loan surge represents a 153 percent increase over the same period last year and
already more than double last year’s net new loans of 4.23 trillion RMB ($619 billion).
This surge in lending has seen the financial institutions’ loan books balloon 29.9 percent
from 32 trillion at the end of 2008 to 41.4 trillion RMB at the end of 3Q2009. While the
pace of lending in the third quarter has slowed, net loan formation could potentially total
10 or 11 trillion RMB by year-end, the equivalent of 33.3 or 36.6 percent of China’s 2008
GDP.
CHART: NET NEW LOANS
The sheer magnitude and pace of this year’s credit extension has raised concern about
credit quality deterioration in the future for a few reasons. First, while 48 percent of the
new loans are medium to long-term corporate loans— ostensibly earmarked for
infrastructure projects and existing capital expenditure—it is likely that credit has been
extended to projects that are fundamentally infeasible, and therefore portend Chinese
“bridges to nowhere.”
There is also body of evidence that suggests a significant portion— estimated at X billion
RMB, or about Y percent of total loans— has not gone actually gone into the “real
economy,” but has instead been used to stockpile commodities and to speculate in
China’s stock and real estate markets.
Though anecdotal evidence suggests
misappropriation of funds was endemic, it is likely that the most egregious fraud was
articulated through corporate bill financing, which is basically a payday loan against
corporations’ receivable earnings—earnings that, in theory, actually exist. Net new bill
financing loans at the end of the third quarter increased by 882 billion RMB, increasing
bill financings total loan book by 44 percent increase—although before the CBRC took
measures to curb it at the end of the first half of 2009, it was as high as 1.7 trillion, an 88
percent increase.
Interestingly, Liu Mingkang, chairman of the China Banking Regulatory Commission
(CBRC), announced on October 23rd that the rate of NPLs in China’s commercial banks
at the end of the third quarter was 1.66 percent, down from 2.42 percent at the end of
2008. To be fair, Liu cautioned against rising NPLs, but the announcement speaks more
to the reliability of China’s statistics than to the health of the banking industry— after all,
the credit surge was predicated on financing corporations whose capital structures and
earnings outlooks were both fundamentally weak
China’s definition of NPLs is incredibly merciful by international standards. Typically a
loan is considered to non-performing if its service payments are delinquent by no more
than 60 or 90 days, but according to the PBoC’s 5-teir classification system, loans are
only considered to be non-performing if they’re delinquent by at least 6 months. The
NPL ratio is also lowered simply by the extension of credit in and of itself. By issuing
new, ostensibly “healthy” loans, a given banks’ ratio of NPLs decrease because the total
loan book increases. Therefore it’s easy to see why the recent credit explosion has
flattered the ratio—NPLs (the numerator) are realized with a lag, but total loans (the
denominator) are realized instantly, forcing the ratio lower. This partly explains why
many in Beijing are concerned about rising NPLs should China’s economic growth
slow— without the constant issuance of new, “healthy” loans, NPLs will nominally rise as
their presence is truly felt amidst static loan book growth.
Forestalling the Inevitable
However, while it is clear that the loans surge will lead to NPL formation down the road,
it is also clear that China has the tools and the political will to do whatever is necessary
to ensure growth and keep unemployment low, which is this context means whatever is
necessary to support its banking industry and its ability to lend. The primary objective of
China’s banking industry is not economic in nature, but political. Making profits is both
desirable and commendable, but secondary to effectively prosecuting Beijing’s national
goals, currently the most important of which being allocating subsidized capital to
strategic and exporting industries to keep unemployment low.
In 1999 when the big four state-owned banks were encumbered by loads of bad debt—
undoubtedly a consequence of extending credit, at the behest of the communist party, to
“subprime” borrowers— the central government chartered four asset management
corporations (AMCs) to “purchase” the banks’ nonperforming loans with bonds and
some cash, thereby cleansing the banks’ balance sheets. There is no evidence to
suggest that the government would not, if and when nonperforming loans come a
cropper, once again recapitalize the banks by establishing more AMCs or engineer
cleaner balance sheets through more debt for equity swaps. STRATFOR sources in
China have confirmed that talk of another round of AMCs is not out of the question.
China also has the option of monetizing portions of the banks’ debt. China currently has
a relatively strong national balance sheet— it’s gross external debt at the end of 2008
was $387 billion, it’s public debt of Y is relatively low, its projected deficit was X percent,
it has foreign currency reserves of $2.33 trillion. For these reasons china has not had to
put in place quantitative easing, but China could opt to monetizing its debt because of
their undervalued currency. The undervalued renminbi provides China them scope to
print money in proportion to the increased demand for the renminbi were government
controls over its purchase liberalized. If they overshoot and print too much, they’d just
devalue their currency and boost exports! However this could potentially spark inflation
would be the death knell for the central government as inflation tax away its citizens’
savings.
But perhaps the most serious concern for China’s banking industry is that in the event of
a another sharp and sustained deterioration in the global macro backdrop, corporate
earnings could again decline, thereby pressuring corporates’ ability to service debt
and/or pay down principle, and therefore requiring more stimulus and subsidized credit
from Chinese banks. If the downturn were protracted enough, it could severely limit the
window of opportunity China’s current fiscal position affords it to support its industries
while it attempts to transition its economy from export and investment driven growth to
sustainable, domestic consumption. So while the current levels of lending and support
are unsustainable in the long term, government officials will likely do whatever is
necessary to support business and keep unemployment low, however dysfunctional or
infeasible the projects or their financing may be.