For over a year now, China macro-economy watchers have been waving the red flag about a "ticking time-bomb" in the country's finances, only to see their concerns dismissed as alarmist.
Today, those concerns appear to have been validated, with reports suggesting that the Chinese government has acknowledged the seriousness of the problem and is moving to defuse the financial time bomb.
Reuters reports, citing unidentified sources, that Chinese authorities are planning to bail out local governments to the tune of 2-3 trillion yuan (about $300-450 billion); the tab for this will be picked up by the central government and China's four big state-owned banks.
The bailouts were prompted by reckless - and unauthorised - borrowing by local governments in China's provinces to finance large-scale and unproductive infrastructure projects, following the sharp downturn in the Chinese economy in 2008. Faced with a collapse in exports, Chinese authorities ramped up infrastructure spending, and directed state-owned banks to unleash an avalanche of lending to prop up the economy.
Economists had warned that the mountain of debt could sink China's financial stability and economy, but they were dismissed by China bulls who appear to believe that Chinese policymakers could do no wrong.
Indicatively, Credit Suisse chief regional economist, Dong Tao, had said last year that the fiscal crisis arising from the debt pile-up represented "the biggest risk to China's economic and financial stability over the next two years". He warned that it had the potential to more than completely wipe out Chinese banks' equity base, and trigger an equity market panic when it bursts.
And although it was very hard to determine precisely how much bank lending had been channelled to the local governments, Tao estimated outstanding loans to be about 8 trillion yuan (about $1.2 trillion), about 24% of China's GDP, 83% of overall new lending in 2009, and a whopping 180% of the equity base of all Chinese banks.
The Reuters report claimed, citing its source, that after a month-long investigation into local governments' liabilities, Beijing had determined that local governments had borrowed around 10 trillion yuan.
The current bailout amount it cited addresses less than a third of that estimate of outstanding loans, which indicates that there may be more bailouts to come.
In a recent interview to Firstpost, economist Jim Walker had pointed out that Chinese banks could delay the recognition of bad loans for longer than banks in more open financial systems, but that sooner or later the Chinese authorities would have to confront it."It would be very heroic to be arguing that there's going to be no bad debt problem in Chinese banks. There's a massive one coming; it's not going to be in 2011, probably 2012 and 2013," he said.
Contrary to official Chinese government statistics pointing to rosy debt-to-GDP ratio (about 20%), Walker reckons that China's debt is over 100% of GDP.
The official 20% debt-to-GDP data relates only to central government debt. It didn't , for instance, include debt incurred on China's famed high-speed railway system, which it's now feared could be derailed by the debtburden.
It doesn't also include the bad debts from the crisis in China's banking system in the 1990s, which are still on the books of asset management companies.Nor does it include debts incurred by state-owned enterprises, which ought to be treated as public sector liabilities but aren't.
Adding those off-balance sheet items, China's debt-to-GDP mounts to anywhere between 75% and 125% of GDP. The Chinese business journal Caixin reported recently that as of 2010, the Chinese banking industry's total assets had grown to about 100 trillion yuan (about $15 trillion), or about 2.39 times the national GDP. The surge in China's banking assets, it noted, took off in 2009, and was attributed more to political directives rather than monetary policies.
The surge in banking assets doesn't give much comfort to Michael Pettis, a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University's Guanghua School of Management. On his blog, Pettis notes that "historically, one of the key indicators that the high-growth investment-driven model has reached its limits as a wealth creator (that is, is no longer allocating capital efficiently) is when we see an unsustainable increase in debt."
For now, though, China has the money and the muscle to throw at these debt problems. But the risk is that what we're seeing for now may only be the tip of an iceberg that runs deeper than it seems.
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