Chinese bad debt rockets

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Cross-posted from Investing in Chinese Stocks.

Reuters: China’s top banking regulator warns of rising bad loans, credit risk

China’s top banking regulator warned of rising credit risk from real estate, local government debt and unconventional forms of finance, sources with direct knowledge told Reuters, highlighting Beijing’s struggles to prevent risky debt from engulfing a stuttering economy.

The sources cited a speech given by Shang Fulin, chairman of the China Banking Regulatory Commission (CBRC), during a teleconference in early May.

The amount of non-performing loans in the first quarter has already reached 56 percent of the total amount last year, Shang said, according to the sources. Unconventional forms of credit – which usually refers to instruments like entrusted loans and letters of credit – were also on the rise, he said.

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To clean up this mess local government debt, the Chinese government needs to cut borrowing costs. The central bank lent a helping hand. Since March 31, the three-month Shanghai Interbank Offered Rate (Shibor) has dropped 194 basis points, the largest two-month decline since 2008. In the meantime, the Chinese government launched a debt issuance and the place where the loan is replaced with low yield bonds.

April postpone local government debt issuance last week to start, Jiangsu and Xinjiang issued 3-year bonds with 3% yields, similar to national bond yields. In response, Citigroup analysts said, “some local governments may lose liquidity, all debt burden will be directed to the Central Government. As a result, local government bonds and government bonds is not much difference.”

In the local government launched the size of more than 1.77 trillion yuan (four times 2014) bond issue, the Chinese central bank governor Zhou Xiaochuan has also accelerated the pace of monetary policy relaxation, less than six months, the central bank cut interest rates three times, twice RRR. Banks are the biggest buyers of government bonds, and as interest rates decline, their appetite for local debt will rise further. According to Mizuho Securities Asia estimated that the scale of Chinese local government debt may have reached 25 trillion yuan, bigger than the economies of scale in Germany.

Shanghai asset management center Yiu, Chief Operating Officer Rosanna said the central bank will do everything possible to ensure that local debt issuance costs in the low; if the cause interest rates to rise because of increased supply, so that the cost of borrowing is higher than ever before, and that the debt exchange, what Meaning? So interest rates upward is limited.

The article goes on to discuss the history of local debt:

According to the provisions of China’s current “Budget Law”, the local government in fact has no right to issue local bonds, and the law does not allow the existence of a deficit.

…the first stage is in the middle of 2009 – 2014, due to the national “4 trillion” investment policy to stimulate local financing platform in mid-2009 was a blowout-style development. In the original “Budget Law” framework enacted in 1994, local governments can not issue bonds directly, so in order to raise funds for infrastructure construction, local government financing platform to build thousands called project financing.

The second stage, after “2014 on the key tasks of deepening economic reform opinions” release, this announcement that China will establish muni bonds as the main local government debt financing mechanism, local governments can use the issuance of bonds to raise funds.

In fact, the latter concerns the second phase allows the state issued a series of policies to deal with local debt, thereby entering the third stage, the national implementation of local debt exchange, the local debt packaged into “new” bonds in the market.

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There are many unresolved issues with the plan, such as, are local government’s repaying old debt with new debt, or taking on new debt? Minsheng Bank recently estimated local governments may need to issue 2.3 trillion in municipal bonds in order to repay debt and fund new projects.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.