China's debt spree returns to haunt

**Bangyai** · 12-10-2011, 08:37 PM

Bail-outs are coming thick and fast in China. In less than a week the authorities have had to step in to prop up the banks, rescue the insolvent railway system and save the near bankrupt city of Wenzhou from a spectacular debt crash.

Deposit rates in Chinese banks are -3pc in real terms Photo: AFP

By Ambrose Evans-Pritchard

9:03PM BST 11 Oct 2011

180 Comments

It is proving harder than expected for the central bank to manage a calibrated "soft-landing" after letting rip with credit to counter the Great Recession. The loan spree raised credit from 100pc to almost 200pc of GDP (on IMF estimates), including off-books trusts, letters of credit and sub-radar loans from Hong Kong.

The 30pc annual pace of loan growth is unprecedented in any major country in modern history. It is double the pace of America's housing boom and Japan's Nikkei bubble in the late 1980s. It may match US loan growth in the late 1920s.

The Communist Party is now struggling to cope with the fall-out. On Monday, the state investment fund Central Huijin began buying stakes in China's four top banks to restore confidence and halt the slide in share prices.

The relief rally ignited bank shares on Tuesday. Agricultural Bank of China surged 13pc in Hong Kong. Shanghai's bourse jumped 4pc but is still down 60pc from its peak in late 2008.

China's finance ministry is quietly intervening to underwrite China's railway system. This behemoth is drowning with $300bn of debts after breakneck expansion, is in arrears on $25bn of debts to its two largest suppliers and has run out of money to pay workers on the Lanzhou-Chonqing rail project.

The ministry has offered a 50pc tax break on railway debt to be auctioned on Wednesday. This is a signal that Beijing will stand behind the system. It is intended to lure back investors following the high-speed rail crash in July.

Meanwhile, Bejing is negotiating a $15bn bail-out for the enterprise hub of Wenzhou south of Shanghai, where panic has set off a credit crunch for small business and builders. China's press has been riveted by tales of debtors hiding in the hills to evade creditors.
Roughly 60pc of the region's loans come from non-bank lending beyond control, some of it Ponzi finance. "It's a tight financial network that interweaves lenders and borrowers collectively, often to their mutual benefit and sometimes to their terrible loss," said Caixin Magazine.
"If only a few debt-ridden companies collapse, the financial trouble can ripple through the entire credit-connected community. The domino-effect started to endanger the entire system in July."
While Wenzhou is small enough to contain, it may be an early warning of toxic debts in countless other cities. Jim Chanos, a vocal China bear at Kynikos Associates, said the country is in the early stage of a "very serious pullback" driven by an incipient property bust.
"The fact that people are even talking about the government stepping in to shore up the banks, when two months ago people thought there was nothing wrong with the Chinese banks, should tell you just how seriously this situation is deteriorating," he told Bloomberg.
In fairness, China's central bank has deliberately sought to prick the bubble with a variety of loans curbs. It is cracking down on the "shadow banking system", aiming to choke off $150bn in credit by March. Some slowdown is welcome.
What is not yet clear is whether credit excess has reached a point where even a light tap on the brakes is enough to set off uncontrollable events, and do so just as the global economy goes into a double-dip downturn.
Bin Gao from Bank of America said the central bank's "misguided" policies are draining liquidity too fast and causing funding stress. The "TED spread" used to gauge strains is higher than in 2008.
House prices began to fall across the country in September, according to China Index Academy. The drops have been steepest in cities such as Chongqing and Chengdu deep in the interior, belying claims that froth is confined to pockets of the eastern seaboard. Sales of flats in Shanghai slumped by three quarters during "Golden Week", the Autumn holiday watched as a market barometer.
IMF data show that the price to income ratio for housing is 20 in Beijing, and 14 in Shanghai and Huangzhou, triple the levels in US cities during the subprime bubble.
The comparison may be misleading. China's middle class invest in bricks and mortar because it has few other places to store savings. Deposit rates in banks are -3pc in real terms. Foreign assets are off limits. Home purchases are often paid in cash. Even so, such extremes inevitably create a macro-policy nightmare.
Cheng Siwei, head of China's International Finance Forum, said loan curbs are causing "a lot of difficulties" for local authorities with $1.7 trillion in debts built up through finance vehicles. "The tightening policy is causing defaults. This is our version of subprime."
China faces "very tough period" as the credit overhang and 6pc inflation limit the government's ability to offset slumping demand in the West, he said.
The country's reflex at such times is to weaken the yuan, relying on exports to come to the rescue. That may not be possible this time. The US Senate was poised on Tuesday night to vote for a "currency manipulation" bill that opens the way for retaliatory tariffs against China.
The law is unlikely to pass the House, but the political message is clear. China will no longer be allowed to get away with "economic murder", in the words of Senator Charles Schumer.
This may be a caricature description of Sino-US trade. And as China retorted, such a law would set off a "trade war" that hurts everybody. Yet the reality is that China's options are painfully limited.

China's debt spree returns to haunt - Telegraph

**bigtopskinnylegs** · 12-10-2011, 09:57 PM