Property agony: The Country Garden headquarters in Foshan, China. Once the country’s biggest real estate developer with over 3,000 projects nationwide, it is slipping into a default. — Bloomberg
CHINA’S financial system seems on the brink of collapse.
Country Garden Holdings Co, once its biggest real estate developer with over 3,000 projects nationwide, is slipping into a default.
One of the nation’s largest private wealth managers has been missing payments to investors.
Meanwhile, distressed signals from regional governments, which rely heavily on land sales for fiscal income, keep on bubbling up.
By Western standards, these events would almost inevitably lead to a financial meltdown.
The 2008 subprime mortgage crisis alone brought down Lehman Brothers Holdings Inc, one of the most revered lenders on Wall Street.
This year, the Federal Reserve’s rapid rate hikes prompted a slew of regional bank failures.
Even now, investors are worried about bank loans made to commercial real estate projects, hit hard by white-collar workers’ reluctance to return to the office.
So imagine the double whammy of property wobbles and fiscal woes.
China’s banking system owns 94 trillion yuan (US$12.9 trillion) of local government debt, or 29% of total assets, according to Goldman Sachs Group Inc estimates.
On top of that, there is about a 58 trillion yuan exposure to the real estate sector.
How can China’s Lehman moment not be here already?
This is because China has a very different political economy.
Whereas big US banks are rushing to offload their office building loan books – arguably a beggar-thy-neighbour approach – their Chinese counterparts can just sit tight, pretend and extend.
The central government will reportedly allow a dozen debt-ridden provinces to issue special bonds worth as much as 1.5 trillion yuan for refinancing.
The People’s Bank of China has been cutting interest rates to make monthly mortgage bills more palatable.
Even China Evergrande Group managed to extend its onshore yuan bond repayments despite having defaulted on its international debt.
While none of these measures are sufficient fixes, the liquidity pressure faced by the banks’ customers can at least be somewhat eased.
But China’s tendency to kick the can down the road only hampers its banking system and its economic recovery.
In fact, one may even argue that China needs a Lehman-like scare to cleanse the toxic debt that has been building up for way too long.
Consider local government financing vehicles (LGFVs), or off-balance-sheet entities that municipalities rely on to fund and support local economies.
In recent days, demand for short-term LGFV bonds, especially from lower-rated borrowers, surged in the wake of the government’s rescue effort.
Last week, Tianjin, one of China’s most indebted cities, saw a 1.5 billion yuan LGFV note subscribed by 70 times. Secondary transaction volume has risen as well.This won’t be the first time China has tried to contain LGFV’s credit risk. It has conducted much larger bailouts in the past.
In a 2014 audit, two-thirds of LGFV debt was explicitly recognised as government liabilities.
In the following four years, more than 12 trillion yuan of such borrowings were swapped into official local-government bonds.Alas, that gigantic effort led to nothing.
LGFV debt has rebounded since and last year rose to 57 trillion yuan, or 48% of China’s gross domestic product, according to estimates from the International Monetary Fund.
Bankers and asset managers just can’t let a “Beijing put” go to waste, however stern the central government’s warnings are on LGFV risk.
After an abrupt economic reopening late last year, Beijing has been wanting foreign fund managers to re-engage and buy Chinese assets again.
But the eerily calm banking system is a huge hurdle for investors, who – perhaps because they have very little visibility of what’s happening inside China – just can’t stop fretting over possible financial contagions and blowups.
They worry about Zhongzhi Enterprise Group Co, a private wealth manager overseeing about one trillion yuan that is now behind on payments for its wealth management and trust products.Is Zhongzhi an exception or the shadow banking industry norm?
Do private wealth managers ring-fence their customers’ money? Have listed companies invested spare money into the so-called “cash pools,” where one investor’s money is used to pay back another’s?
In less polite language, these pools can be called Ponzi schemes.
Or how about banks? Because of mortgage rate cuts, lenders’ net interest margin has fallen below 1.8%, a threshold that is regarded in the industry as necessary to maintain reasonable profitability.
Will lenders have enough capital buffers? Can they raise equity in the future? Down more than 7% this year, Hong Kong-listed Chinese banks are now valued at only 0.3 times book.
To its credit, the Chinese government has been a very effective circuit breaker, managing a huge debt pile without a financial collapse.
However, until the country has gone through a Lehman-style cleanse and got rid of some of its most unhealthy borrowings, all foreigners can feel is fear and loathing – fear that China is “a ticking time bomb,” while loath to be caught in the middle of an explosion. — Bloomberg
Shuli Ren is Bloomberg Opinion columnist. The views expressed here are the writer’s own.
