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Are We on the Verge of a Chinese Credit Crunch?

July 11, 2018 in Economics

By Diego Zuluaga

Diego Zuluaga

If China were a Eurozone country, it would likely be regarded as
the next victim of the bond vigilantes.

The People’s Republic has more than doubled its stock of private
credit relative to GDP in the last ten years, even as output grew
at annual rates exceeding 6.5 per cent. Indeed, China accounts for
fully one-third of the global increase in private debt since the
financial crisis.

Only Ireland and Spain, at the height of their ill-fated housing
booms, can rival the Chinese credit explosion in rapidity and
scale.

Investors might be reassured if Chinese credit markets were free
and transparent. But that is manifestly not the case. Lending is
dominated by the “Big Four”
state-owned banks that were spun off from the People’s Bank of
China in the 1980s, as market reforms got under way. They still
account for 60 per cent of bank assets, most of which are loans to
state-owned industrial enterprises, often extended according to
political rather than business criteria.

The retail side doesn’t look much better. Until October of 2015,
bank deposit interest rates were capped. Such financial
repression not only fattened bank profits at the expense of their
depositors, but it also encouraged Chinese savers to reach for yield by buying houses,
speculating in illiquid stocks of largely state-owned companies,
and acquiring investment products in the country’s burgeoning
shadow banking sector. All three markets have of late shown signs
of overheating.

If China were a Eurozone
country, it would likely be regarded as the next victim of the bond
vigilantes.

Not all is bad news. Non-performing loans, which in the wake of
the 1997 Asian financial crisis represented an eye-popping 25 per cent of
total loans, have been brought down to manageable levels through a
mixture of public and private recapitalisation, and the purchase on
favourable terms of toxic assets. But even here, Chinese taxpayers
have had to pick up the tab for the bad decisions of state
cronies.

And it hasn’t been the astute management of Communist Party
chiefs that has helped the country avoid a financial crash so far,
but the breathtaking growth rates that China averaged between the
early 1990s and 2008. When an economy is growing at 10 per cent per
year, the weight of bad loans can halve in ten years, even with the
absolute value of bad loans growing annually at 3 per cent.

But a number of things have changed since 2008. Firstly, Chinese
growth seems to have permanently slowed. Official growth rates have
hovered around 6.5 per cent since 2015, one-third below …read more

Source: OP-EDS

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