China watchers can’t have helped noticing that the economic news coming out of the country was beginning to look more positive towards the end of summer. Purchasing Managers’ Indices (PMIs) have improved, house prices are pushing ahead again, the Shanghai Composite Index has made gains, and the Industrial & Commercial Bank of China (ICBC) has returned to its position as the world’s biggest bank as measured by market capitalization.
Indeed, there are growing signs in China that some sort of “mini-stimulus” has been carried out to counteract what Beijing had probably been viewing as an alarming slowdown throughout the first half of 2013. As discussed elsewhere in The Diplomat, China’s slowdown was placing increasing pressure on the country’s financial system and economy with all the potential problems such pressure could cause. The measures that are emerging could be seen as an attempt to halt or reverse the overall slide, but more significantly they are likely ways to buy more time so that the necessary reforms can be enacted at a slower, less disruptive pace.
The signs of this mini-stimulus (or slight easing) emerged piece by piece throughout the summer, and came on top of yet another credit surge in the first part of the year. For example, reports showed that the Agricultural Bank of China (Agbank) was extending a large line of credit to the city government in Shanghai. The RMB 250 billion loan (equivalent to more than 10% of the city’s GDP last year) will be used in part to fund the entity controlling the Shanghai Disneyland project, and also to support development of the city’s long-awaited free trade zone.
In another sign, the gigantic China Development Bank (CDB), one of Beijing’s formal policy banks, was reported to have signed MOUs with three provincial governments: Hebei, Jiangsu and Qinghai. The financing that will follow will be used for various projects, including at least one more airport as well as public housing, waterways and regional transport infrastructure.
The fact that it was local governments popping up in these reports raised a few eyebrows among China watchers, since the country’s National Audit Office is currently undertaking a massive audit of all government debt. This audit was ordered by Li Keqiang’s State Council, and followed a confession by Vice-Finance Minister Zhu Guangyao that Beijing didn’t know the full extent of local government borrowing – which all agree has spiked since 2008. Estimates for the total amount range to above USD$3 trillion, with some provinces and lower level governments being particularly exposed.
Even before the audit got underway, suspicions were raised about how much, if any, information would be made public and how reliable it would be. It is clear that Beijing at least needs to know what the situation is as the economy enters its phase of restructuring and rebalancing, but even that is not assured.
So what exactly is Beijing doing in the face of slowing growth and an uncomfortable turn towards pessimism? It is clear that avoiding or delaying the emergence of significant financial distress, particularly in the form of explicit non-performing loans (NPLs), might be considered. The three usual methods of doing this are either to write down the NPLs and bail-out some of the entities that end up in crisis, roll-over the troubled assets with new lending and restructuring, or transfer the bad debts somewhere else, thus freeing up the normal financial sector to continue lending despite previous mistakes.
Municipal bonds issuance, shadow and formal lending all facilitate the ongoing expansion in outstanding credit (from already high levels). That credit expansion in turn enables growth to continue and previous non-performing assets to be papered over. This process appears to be continuing and constitutes one string in Beijing’s bow.
The last time that China’s financial sector got itself into an NPL nightmare en masse was during the late 1990s. At that time, along with extended financial repression, NPLs were transferred to “Asset Management Companies” (AMCs), which served as de facto bad banks, at face value. This freed China’s banks to “clean themselves up” and convince both foreign and domestic investors that they were normal commercial entities who had reformed from the old ways of politically motivated lending. That illusion may have collapsed after 2008, and the AMCs may have abjectly failed to work off the bad debts in a timely manner, but it certainly was a way of kicking the can down the road.
Now, following years of quiet, unspectacular expansion, China’s four AMCs are suddenly popping up in the media again. Both Cinda and Huarong are now the focus of some investor interest ahead of expected initial public offerings next year, and indeed their financials have started to mysteriously improve (as the Financial Times’ Alphaville blog noted last month).
Huarong is reported to have already been in talks with Morgan Stanley, Goldman Sachs and Deutsche Bank ahead of the anticipated listing and one wonders what the “lock up period” is going to be once shares are issued and begin trading. Cinda meanwhile is also said to be planning its own offering for Hong Kong and has already received financing from investors such as Standard Chartered and UBS.
China’s “bad banks” do have some attractive traits, since they have built up a multitude of financial licenses and now have subsidiaries and divisions involved in a wide range of activities, and they do have experience (if not overly successful) at working down non-performing assets in the country. Either way, the remarkable return to health and apparent bid to attract foreign capital to these AMCs gives the impression that they are getting ready to help the financial system once more.
Indeed, these are not the only signs that a financial cleanup may be imminent. The central level AMCs previously tackled central government controlled banks’ bad debts. This time, as mentioned above, it is local governments that are under the spotlight. Thus it is worth highlighting what Eve Cary pointed out in June: that authorities in China have recently permitted the creation of local AMCs.
Yet another sign of a potential clean up is the renewed interest in the securitization of bank assets. Anyone schooled in the proximate causes of the recent global financial crisis will well understand the role this practice played in obfuscating risk and allowing lenders to make profits without paying note to the underlying creditworthiness of their borrowers.
Although in China securitization is still at an experimental stage, the renewed interest in credit asset securitization (CAS) announced by the State Council in August could be a preparatory step with an eye toward providing further financial relief – especially to institutions having to roll over or restructure assets of dubious quality. Equally banks with significant off-balance sheet lending could see securitization as a route to keep such lending away from their books.
An urgent local government debt audit, an unfolding mini-“stealth stimulus,” the re-emergence of the original AMCs, the new rules regarding local AMCs, and a renewed interest in the securitization of credit assets…These factors, when taken together, align nicely with the idea of a reform-motivated central government, concerned about the disruptive and complicating effects that debt-related financial distress could bring, seeking to buy time to implement the necessary painful reforms at a slower pace.
Hence, although the data may be showing improvements for now, there will be further downs (and ups) over the coming quarters as policymakers in Beijing walk a very fine line on their route to a more sustainable economic system.