China: the price of directed lending

China: How long can that heart rate stay elevated?  Source: Google Images
China: How long can that heart rate stay so elevated? Source: Google Images

China is an economically successful country.  Growth rates of 8-11% per year.  Fx reserves north of $2.4 trillion, closing in on 20% of US GDP.  Investment rates that represent 40-50% of GDP (vs. 15-20% in the US).  Private credit growth of 32.5% last year, vs. 5.6% in the U.S.   A Human Development Index that now stands at 49.7, vs. 26.5 in India, and per capita income (PPP basis) that is twice as large as India’s.  Can China keep this up?

I have long said in this blog that China is not strictly comparable to Western market economies, where governments use market signals such as interest rates to nudge the massive private sector in a certain direction.  In China the central government directs banks to lend and pushes local governments to invest.  Not to scoff at the stimulus packages in Western countries — featuring government spending and liquidity injections, but in China, when the authorities mandate a stimulus, they sure get one.   The lead lining in the silver cloud, however, is that when loans and investment projects “season” in China, sizeable loan losses and fiscal liabilities can result.  This is just what rating agency Fitch argued at a conference in Shanghai and Beijing last week (see press release below).   

China has the wherewithal to handle some deterioration in its banks and sovereign balance sheet, given its low level of government debt (under a quarter of GDP), small deficits (under 3% of GDP), and full inoculation against a balance of payments crisis (featuring its Chinese wall of fx reserves and current account surpluses in the neighborhood of 5-10% of GDP).  Nevertheless, with a massive banking sector (broad money represents over 180% of GDP) and heavy state involvement in the sector, banking problems could conceivably become sovereign debt problems.  Fitch assigns China a Banking System Risk Indicator of D/3 (vs. C/3 in the US and B/1 in Canada).  This statistic ranks countries based on the quality of their banks (A-E, E being the lowest) and on systemic banking risk (1-3, 3 being the highest risk).  So, directed lending and stratospheric credit growth have a dark side. 

Furthermore, as Fitch suggests, China, like Japan, will have to shift to an economy driven more by its consumers and less by external demand (i.e. exports) in order to respond to angry trading partners like the U.S. and to have a more sustainable trajectory of economic growth.  Such a shift will be even more difficult with problems in the banking system and higher government debt.

Fitch: China’s Ratings Supported By Strong Sovereign Finances, But Possible Stimulus ‘Hangover’
17 Sep 2010 2:01 AM (EDT)


Fitch Ratings-Beijing/Singapore-17 September 2010: Fitch Ratings says China’s ratings remain supported by the sovereign’s strong finances, underpinned by the foreign reserves stockpile, and by the economy’s strong growth track record. However, the agency raises concerns over a potential ”hangover” from the government’s aggressive stimulus efforts in 2009, including strong credit growth, which could still see the emergence of problems requiring sovereign support to clear up, for example in the banking system. The hesitant recovery of the global economy remains a background source of risk for China.

Leading off Fitch’s annual Sovereign and Banking Conference in Shanghai and Beijing this week, Andrew Colquhoun, Head of Asia-Pacific Sovereigns, reviewed China’s robust economic performance through the global crisis. China’s strong growth owes much to the government’s stimulus efforts, but Mr. Colquhoun noted that some of the costs of the stimulus may be yet to materialise on the sovereign’s balance sheet, such as debts of local government investment companies and, in a downside case where banking sector problems emerge, holes in bank balance sheets. Mr. Colquhoun also discussed the longer-term prospects for a transition to a more consumption-led growth model in China in the context of a still-hesitant global economic recovery – potentially a bumpy transition.

Speaking on the prospects for Asia-Pacific banks, Jonathan Cornish, Head of Fitch’s North Asia Financial Institutions team says the agency sees risks building in banking systems across the region, particularly in China due to rapid asset growth – even though Asian banking systems have generally proved resilient during the global financial crisis, and have in general continued to benefit from a relatively benign operating environment as a result of the robust performance of many Asian economies.

Charlene Chu, Fitch’s Senior Director of Financial Institutions, provided an update of Chinese regulators’ efforts to curb the risks surrounding the growing popularity of informal securitisation, or the re-packaging of loans into wealth management and/or trust products, by Chinese banks. Ms. Chu was one of the earliest analysts to raise awareness about informal securitisation in China. She said that despite the recent tightening in regulations, net issuance of some wealth management and trust products has not slowed thus far in Q3, owing to a number of grey areas in the new rules that offer banks significant room to maneuver with this activity.

Li Zhenyu, director of financial institutions and structured finance at Lianhe Ratings, Fitch’s JV partner in China, also discussed the evolution of formal asset securitisation in China.

Contacts:

Andrew Colquhoun
+852 2263 9938
andrew.colquhoun@fitchratings.com

Jonathan Cornish
+852 2263 9901
jonathan.cornish@fitchratings

Charlene Chu
+86 10 8567 9898 ext 112
charlene.chu@fitchratings.com

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