China not slowing enough

The People’s Bank of China has raised interest rates and reserve requirement ratios a number of times since last year as the government pledged to make inflation fighting and property price curbing their top priority.  So far, the two main objectives have not been achieved.  However, the effect of tightening has been increasingly visible.

For instance, tightening means that potential home buyers are now finding it difficult to obtain mortgages to buy real estate according to the WSJ.  As the government implemented buying restrictions in various cities, demand for real estate has declined sharply, leading to a decline in transaction volumes in various cities. Prices have held up so far.

But it is not clear for how long.  Since early last year, major developers have raised more than US$11 billion in Hong Kong through the debt market, most of them with coupon rates above 10%, highlighting the high demand for credits and the increasingly tight credit conditions in China.  Real estate developers in China have seen their  profits drop and debt levels increase in the first quarter of this year, and they now have about RMB1 trillion debts in on balance sheets, while inventories are shooting up as sales have slowed according to various sources.

Local governments may also run into some financial difficulties as the real estate market cools.  Local governments are very dependent on land sales and other property-related income as their revenue sources, thus a quiet real estate market will hurt many local governments.  Indeed, the city of Haikou has already announced that they will suspend the buying restrictions for real estate because the government’s revenue fell, according to EEO.

As banks restrain lending, the only companies which can still obtain credit are state-owned enterprises.  As a result, other businesses, particularly small and medium sized companies, are having difficulties in obtaining credit at all.  To cope with their financial difficulties, we have started to hear stories of  borrowing from loan sharks which charge horrendous interest rates according to various sources. Pawnshop businesses like Credit China (8207.HK) are booming.

As the objectives of slowing inflation and curbing home prices have not been achieved despite the tightening of credit and signs of a slight slowdown of the economy, any easing of policy is not likely in the near-term.  The consensus remains that the most likely outcome will be a soft-landing, in which growth is sustained at a relatively strong level while inflation and home prices fall.  Yet the recent developments confirms my long-held view that the economy needs to be slowed down significantly in order to achieve the stated objectives.  It appears to me, therefore, that the probability of a so-called hard-landing is still being under-estimated by global markets.

Also sprach Analyst

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  1. Cool. Someone on the ground in China (well, HK) here at MacroBusiness. I’ve stumbled on your blog a few times via Business Insider I think. Welcome.

    I’d appreciate your thoughts on Andy Lees note about NPLs reported in BI today…

    Unfortunately there is yet another area of concern starting to build in China, that of its finances. We have heard the recent stories about companies using letters of credit to import copper or soybeans and then using the proceeds to support other debt, but this is just the tip of the iceberg. You may recall back in 2006 Ernst & Young issued a report that China’s bad debts may be as high as USD900bn, outstripping the country’s massive foreign exchange reserves at the time. Aside from large banks, the estimate includes bad loans in state investment companies, credit cooperatives, and other vehicles set up by the government to dispose of the loans. At the time the government dismissed this as fantasy and Ernst & Young were forced to withdraw the report, presumably if they wanted to continue lucrative business in the country. Fitch, PriceWaterhouse and McKinsey Global Institute subsequently issued reports, which although not quite as extreme nevertheless made similar observations and suggested that the problem was significantly worse than Japan’s 15 years earlier. Fitch said official NPL’s were USD206bn with another USD270bn problem loans plus another USD197bn in NPL’s that have been taken off the bank’s books and with the management agencies, which are not treated as NPL’s, but are future liabilities on the government. That USD673bn it said was a very conservative estimate due to the quality of accounting etc, and was therefore not credible. It said in reality the figures would be far higher and “Given the weakness” already discussed, we believe Chinese banks remain acutely vulnerable to an economic slowdown”. You cannot prepare to deal with a loan situation as bad as China’s. You simply keep cycling as fast as possible and hope something turns up.

    Just FYI: It is considered something close to heresy in Australia to suggest that China might slow down significantly. The baseline scenario of every economic projection from Treasury, the RBA and ABARE is 20 years of uninterrupted strong growth in China, and for Australia’s terms-of-trade to remain significantly above historical averages.

    • I did stumbled upon the Australian Treasury’s comments, although Dr. Parkinson is certainly aware of the risk.

      What I would say is that there’s a lot of debts all around China. The problem is that perhaps we can’t quite trust the official numbers, so it is hard to say exactly how much. What we can probably be certain is that the official numbers are likely understating NPL.

      The worrying signs we see now is that because the banking system is tightening credit, small and medium sized businesses are finding it hard to obtain any credits at all. We have already seen stories of bankruptcies of some sizeable companies in Wenzhou. If this condition continues, we should not be surprised in NPL increased sharply.

    • Really? To quote from the piece you link to…

      Dr Parkinson said there was nothing Australia could or should do to lessen its dependence on China, and he added that he remained confident its long-term outlook would be positive for Australia. “The amount we export to China is only slightly larger than our exports to Japan, and I haven’t heard anyone say there is a terrible risk tying our economy to Japan,” he said.

      Treasury’s central case is that China will continue rapid growth, with Australia’s terms of trade (export prices compared to import prices) forecast to fall only 0.25 per cent over the next year.

      Doesn’t sound like much has changed.

      • Agreed.

        But think it through.

        Q. Why say anything negative at all?

        A. Cover your @$$. Just in case.

        I’ll lend you my complete series of Yes Minister and Yes Prime Minister if you like 😉

  2. “Local governments may also run into some financial difficulties as the real estate market cools. Local governments are very dependent on land sales and other property-related income as their revenue sources, thus a quiet real estate market will hurt many local governments.”

    Sounds similar to the problems we face here.

    Good writeup, a welcome perspective and background added to the MB crew.

  3. It’s easy to prevent a ‘bad debt’ problem when the real interest rate is negative due to high inflation. The Chinese Central Bank have no qualm with handing out money. No bank will be allowed to collapse, although a few bank managers will go to the gallow for ‘corruption’.

    The real estate prices in China has reached a point where it threaten the social ‘harmony’ of the society. The key event to watch will be the 30 million or so public housing that is planned. Will they be built? The units can be purchased by the occupier after a period, so they’ll have a serious impact on non-public housing. Can the entrenched interest sabotage the project? That will be the big issue.

  4. I think this is the start of what Jim Chanos has been saying about China. ” Its on a treadmill to hell and is Dubia x 1000″ I think his words are about to ring true soon.

  5. Bloomberg is running a series of videos about China. However, i am not sure how i can embed the link. So, try and search by title:
    1) Bloomberg Television’s “Behind The Wall”: China’s Ghost Cities
    2)Bloomberg Television’s “Behind the Wall”: China’s Growing Middle Class

  6. Had just read this yesterday – indeed the author believes China needs to experience a deep slowing or recession to effectively quash inflationary pressures.

    From the same site:
    “Some people are bearish on China because they really want China to collapse…”

    ‘Want’…A mindset that appears widely held by comment posters at MB. No doubt because they believe it will bring about the end of the two-speed economy in Australia. Asinine in the extreme.

    “On the other hand, the hyperbolic language of the debate is frequently moronic. Unless we’re talking about regime change or fundamental economic collapse (the latter of which would probably cause the former), a couple of points of GDP growth isn’t a game changer for anyone. Unless you’re one of those freakazoids who spends his day watching numbers scroll along at the bottom of a television screen, freaking out at the slightest fluctuation. “

    China is slowing, slightly. Inflation is a problem.

    Corruption is a bigger problem.

    • You got Rio shares mate?

      As Pettis and many other commentators have repeatedly said, what’s required in China is a slowdown in investment and a pick up in domestic consumption. This is an absolute necessity if China is to make the transition from a developing to a developed economy.

      Unfortunately for Australia we have put all our eggs in the China Investment Boom basket, because that’s what’s driving demand for our iron ore and coal.

      This is not about wanting China to crash, its about China needing to rebalance.

      • You’re preaching to the converted here, Lorax.

        However, there is a subtle distinction between recognising China’s need to rebalance, which I do – and harbouring an economic ‘death-wish’…I seem to recall that even you may have expressed a desire to see China ‘crash and burn’ ‘the sooner the better’ – to be fair perhaps not quite so harshly, simply paraphrasing.

        Anyway, we appear to be on the same page now.


        • I don’t think anyone wants China to collapse, 3d1k, I think they don’t want an unsustainable bubble to grow any larger because the longer the wait, the bigger the disaster. Best to nip this imbalance in the (relative) bud.

          • Dont think anyone wants China to collapse?? nope, the US (and allies) would love China to continue the boom for the next 10 years and become the economic powerhouse of the world….

        • I don’t believe I’ve ever expressed a desire for China to “crash and burn” but perhaps I did in one of my more excitable moments. I’ve certainly expressed the view that I’d rather run my business under the economic conditions that currently prevail in the US than Australia (i.e. weak currency, weak employment market, highly skilled workforce).

          As Pleb says, if China doesn’t reign in their investment bubble today the chances of a hard landing tomorrow increase.

    • Perhaps my impression is wrong. What I can see is that some folks like Gordon Chang has been predicting a collapse of China for quite a while. Others in the West (probably the US), as far as I can tell, are quite concerned about the rise of China which may overtake their own superpower.

      On the other side, there are people like Shaun Rein who are so bullish to a point that even a slowdown (not a crash) looks impossible for them.

      The reality of the matter is, China needs to slow investment and increase consumption. Yet what is happening now is that if investment is slowed down, consumption is simply not strong enough to pick up the slack. In order to keep the GDP growth going, the Chinese government has delayed its rebalancing for years.

      In some ways, China is running out of time in terms of rebalancing. Such rate of investment growth is not sustainable, but the slowdown of it without pick up of private consumption, in my view, would be very deflationary.

      Let’s hope that the Chinese government is able to balance that, although I also have to stress that the Chinese government is not omnipotent.