China lending curbs will hit global property bubbles
on April 28, 2015

China lend Apr15

China’s interest bill this year is around $1.7tn, according to ratings agency Fitch.  And no, the “tn” isn’t a typo. China’s interest bill is indeed around the total size of India’s economy, and larger than the economies of S Korea ($1.3tn), Spain ($1.4tn) or Mexico ($1.3tn).

Common sense tells us that no economy can afford to pay out 17% of GDP in interest bills.  But this was the position inherited by President Xi and Premier Li when they took office, two years ago:

  • In 2007, each dollar of credit added 83 cents to GDP
  • By 2012, each dollar was only adding 29 cents; in 2013, a dollar added only 17 cents
  • Estimates suggest the figure for 2014 was as low as 10 cents

This is the problem with stimulus programmes in the New Normal of ageing populations and collapsing fertility rates. China’s demographic dividend has turned to a demographic deficit.  So stimulus spending merely creates a mountain of debt, rather that the expected rocket-fuelled growth.

Reducing this debt is thus a key priority for the leadership, as The pH Report noted a year ago in “China bank lending: From $1tn to $10tn and back again”.  The chart above highlights the change in direction now underway:

  • It shows Total Social Financing (TSF) segmented by Official (green area) and Shadow Bank lending (red)
  • TSF peaked in Q2 2013 at $250bn/month, versus just $90bn/month in Q1 2009
  • Q1 2015 data showed it had fallen 14% to average $210bn/month – still far too high, of course

The chart also highlights the government’s strategy for reducing the debt:

  • The first priority was to bring shadow banking (unregulated lending) under control
  • These were the loans that had financed the “collateral trade” and China’s property bubble.
  • They had more than doubled from $60bn/month to $135bn/month between Q2 2013 and Q2 2014

Stopping this shadow lending outright would have crashed the economy.  Instead, the tactic was to move the lending back into the official sector, where it could then be properly controlled.  Q1 data shows that the tactic has worked, with shadow lending reduced to $77bn/month – and March was just $41bn/month

In turn, this has led to bankruptcies in the property sector.  First to go was Peach Blossom Palace a year ago for $563m, and since then the sums involved have risen – thus Kaisa Group defaulted last week on $2.5bn of debt.  As the Wall Street Journal warned last week:

More than 2/3rds of the liabilities owed by China’s publicly-listed real-estate and construction companies is owed by those with dangerous levels of leverage, defined as liabilities exceeding 3x common equity”

LOCAL GOVERNMENT DEBT IS NOW BEING REDUCED
China debt Apr15This highlights a bigger problem.

China’s private sector debt is now twice the size of the total economy, its ratio having almost doubled since the 2009 stimulus began.

And at the same time, the debt owed by China’s provincial governments has soared to Rmb 17.9tn ($2.89tn), as the chart from the Financial Times shows. Much of it also related to property development.

In the past, this debt was hidden via the use of LGFVs (Local Government Financing Vehicles).  But China’s parliament blocked this loophole last year, forcing the loans to become public.  Now the provincial governments are being forced to try and refinance under a $161bn bond auction plan.

Unsurprisingly, the auctions are having mixed success, just as the Politburo intended.  Both Jiangsu province on the coast, and inland Anhui province failed to sell their debt in auctions last week.

THE SLOWDOWN HAS GLOBAL IMPLICATIONS
Earlier this month, Premier Li made the leadership’s position very clear on a visit to the North-East:

“Intentional neglect of duty has added up to an ill-structured economy. … I felt upset when I saw industrial equipment standing idle along the roads when I traveled through Changchun.  

“Why was it there? Was it waiting for the next project? Land has been wasted without being developed, and officials have to be held accountable.

Of course, the main effect of this major restructuring will be felt in China.  But investors have loaned vast sums to China’s property developers, without asking too many questions as to how it would be used.

Large amounts have almost certainly found their way into overseas property markets such as New York, London, Sydney/Melbourne, Singapore and other major cities.  They are therefore also at risk as China’s lending bubble cools.

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