After the PBOC and CBRC announced a unilateral change in debt policy that allowed indebted Chinese provinces to swap their high interest short term debt for long term low interest bonds which banks would then present to the PBOC as collateral for cash to use for additional lending, it seemed like the forced restructuring would ease the pressure on local governments for a while.
However, Friday night the Chinese central government through the Ministry of Finance, along with the PBOC and CBRC, jointly announced a policy intended to further aid local governments. In the words of the Financial Times, the regulation:
“…told financial institutions to keep lending to local government projects even if borrowers are unable to make principal or interest payments on existing loans….(the regulation) explicitly banned financial institutions from cutting off or delaying funding to any local government projects started before the end of last year and said that any projects that are unable to repay existing loans should have their debt renegotiated and extended.”
Let me say that again just so it sinks in: banks were told to keep lending money even if the borrowers are unable to make principal or interest payments on existing loans and banks are forbidden from cutting, denying, or delaying loans. While country policy makers around the world have unofficially encouraged excessively loose credit policies and lenders may take such policies in individual cases, I have never heard of a similar countrywide or bank wide policy anywhere. (If anyone knows of a comparable case please let me know).
Though they are mostly speculative, there are many inferences that can be drawn from this latest announcement.
- The local government debt problems surrounding the $3.5 trillion USD are much more widespread and profound than is currently recognized by people outside the Chinese government, the banks, PBOC and CBRC. For comparison sake, imagine Barack Obama and Janet Yellen announcing a similar policy for all local governments and banks in the United States. If the bad debt was limited to even a handful of provinces or loan types, we would not be seeing these types of policies.
- The bankers must really be resisting the new policies. For the last month as news began to trickle out about this policy shift, we saw how the bankers didn’t want to buy the new bonds, didn’t like the pricing, the duration, and now the regulation tells them to keep lending even current borrowers are unable to service existing debt. This can only be interpreted as a public and strict ordering of bankers to walk the line set by government.
- If debt problems were more limited and bankers were complying this policy would never have been made public in China.
- If the bankers are telling you what they think of the debt problems in China by resisting even the early forced restructuring, what is the government telling you by announcing ability to service debt is not a requirement for more lending and forcing banks to lend? Given the information asymmetries in Chinese financial markets, it helps to judge how those that should know behave. This policy appears extremely desperate by the government indicating their level of concern.
- 7% GDP growth and 1% non-performing loan ratios are both figments of a CCP statisticians imagination. Even in a world where an NPL is only counted after a firm is bankrupt and non-operational for a year, the GDP and NPL numbers are simply fairy tales.
- China through a combination of policy and luck grew its way out of the last bad loan build a little more than a decade ago. There are banks that still carry the bad loans from a decade ago and some very large companies have been started out of these assets. However, even without a significant growth slowdown much less what even the Chinese government touts as “the new normal”, it will be extremely difficult to replicate the debt swallowing growth of the previous decade. China cannot count on outgrowing its debts again.
- Beijing and Shanghai do not represent China. Declaring the health of the Chinese economy based upon trips to these two cities is like visiting New York City and Washington DC and saying the economy looks great. It is also worth noting that Beijing and Shanghai are two of the most indebted subnational provinces in all of China.
- Expect to see a significant portion of the bad debt end up at the PBOC with no recourse back to the bank if the debt goes bad. The PBOC printed enormous amounts of money to keep the exchange rate low and the money supply rising in the past decade. Their new strategy seems to be to print money to lend out via low credit quality collateral.
- The private sector is being forced to bail out the government.
- I wonder what bank shareholders will think about their capital being forced to be lent without an obvious path to repayment. No wonder the market was pricing in bad news during the recent stock market runup.
- China remains an economy completely dominated by the state. As one economist who argued that the true state share of the Chinese economy was closer to 80% of GDP, just because it is a listed company does not mean it is a private company. With the exception of Alibaba, there is virtually no major Chinese company where the state does not have, frequently through Cayman shell corps in true capitalist fashion, a major holding in most every company. Banks as extensions of the state are following the orders of their major shareholders.
- While I would definitely be categorized as someone who has significant concern about the risks in the Chinese economy, and I respect many economists who are more sanguine about these risks, at this point I struggle to understand how anyone can see these signals from the Chinese government and not be very concerned about the buildup of financial risk.
I hope I am wrong about what I see as the financial risks as signaled by the Chinese government are extremely large.