Chinese investors are worried about a crackdown on debt – should we be too?


Investors should have been celebrating reports that China’s economy continued to power along in the second quarter. Instead, they are worried that the country’s growth remains heavily dependent on credit and investment, at a time when China’s top officials are signalling that the days of easy credit could be coming to an end.

On Saturday, Chinese President Xi Jinping stressed the importance of reining in vertiginous debt levels in the world’s second largest economy and encouraging state-owned businesses to reduce their leverage.

As part of this program, he announced a new high-level committee would be set up to better co-ordinate financial supervision and close regulatory loopholes.

In case anyone missed the signal, The People’s Daily – the Chinese Communist party’s official mouthpiece – published a front-page article on Monday, which urged an escalation in the fight against “the risks that come from liquidity, credit, shadow finance, abnormal fluctuations in capital markets, as well as insurance market and real estate bubbles”.

It also warned of the risk of “grey rhinos” – highly probable threats with major impacts that people should anticipate, but often don’t.

The worry that Beijing may finally be getting serious about tackling soaring debt levels rattled Chinese investors yesterday, with the Shanghai Composite (China’s benchmark equity index) closing 1.4 per cent lower, while the Shenzhen Composite Index (which has a bigger representation of smaller, privately owned companies as well as a number of property developers) slumped 4.3 per cent.

The sell-off occurred even though the latest figures, released Monday, show that the world’s second largest economy expanded by 6.9 per cent in the second quarter, matching the impressive pace it set in the first three months, and easily beating economists’ forecasts. The strong result means that the Chinese economy should easily meet Beijing’s official growth target of “about 6.5 per cent” for 2017.

Analysts, however, are worried that the figures show that Chinese factories are ramping up their output, and further boosting investment levels, which flies in the face of the official rhetoric of encouraging consumption-led growth.

Instead, Beijing appears to have reverted to its old growth model, with its heavy emphasis on exports and huge levels of spending on investment. Not surprising, this is exacerbating Beijing’s already considerable debt problem.

Debt surges

China’s total debt – which households, businesses (excluding banks) governments and local authorities – now stands at more than 250 per cent of the country’s GDP, a huge increase up from about 150 per cent of GDP at the end of 2006.

The surge in Chinese corporate debt is even more alarming – it has more than doubled since 2008, and now stands at more than 160 per cent of GDP.

This tidal wave of credit has resulted in massive industrial overcapacity, triggering global tensions as other countries complain that China is dumping its surplus steel and aluminium in global markets, at artificially low prices.

But the overcapacity is also creating domestic financial stability issues, because it’s highly likely that some large state-owned companies, which are unprofitable and poorly managed, will probably never be able to repay their debts. Meanwhile, the easy availability of credit is continuing to stoke real estate bubbles.

Ratings agencies are starting to take note. On Friday, Fitch maintained China’s credit rating, but warned of the risk of economic and financial shocks, as the country continued to add to its debt levels as it strove to meet ambitious growth targets.

Moody’s Investors Service took a tougher line. Two months ago, it cut China’s credit rating for the first time since 1989, warning it expects the country’s financial strength will erode in coming years as growth slows and debt continues to mount.

But as Chinese investors get jittery, and ratings agencies issue increasingly sombre warnings, how worried should Australian investors be?

After all, Australian resources groups, such as BHP Billiton, Rio Tinto and Fortescue Metals Group, have benefited hugely as rising Chinese industrial output, has boosted demand for commodities such as iron ore and coal.

Analysing risks

Most analysts warn that, at least in the short term, there’s little risk that Beijing will put the brakes on Chinese growth. Xi’s attention, they say, will be firmly focused on the Communist Party Congress in November, where he is expected to consolidate his power base by promoting his allies to key positions. Ahead of this event, he’s unlikely to do anything that would cause economic activity to brake sharply.

Even after the Congress, they argue that Beijing will be wary of drastically cutting back on credit and forcing a widespread restructuring of inefficient companies. Top Chinese officials know that this would cause unemployment to spike, potentially fuelling social unrest.

What’s more, they argue that because most of China’s debt is denominated in yuan, and consists of loans made by state-owned banks to state-owned companies, there’s little likelihood of a major financial collapse.

Instead, the major risk is if they don’t take some action to curb the relentless rise in indebtedness, the Chinese economy risks following down the Japanese track.

They fear that, just as happened to Japan 30 years ago, China’s growth could grind inexorably lower as the country’s banks stop lending to new innovative companies, because their books are clogged up with loans to “zombie” companies.

by Karen Maley
Financial Review


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