Why China´s corporate debt is riskier - Sara Hsu

+Sara Hsu 

China´s corporate debt last week outstripped the US, according to a report by Standard and Poor´s, a staggering US$14.2 trillion at the end of 2013. But it is not only the size that matters, writes financial analyst Sara Hsu in the Diplomat. China´s corporate debts is very different from that in the US.

Sara Hsu:

The difference between the debt structure of corporations in China and the U.S. is crucial. In terms of non-bank borrowing: while Chinese borrowings from the shadow banking sector are neither guaranteed by the state nor by deposit insurance, and generally meet lower standards of risk with low to no transparency, U.S. borrowings from the corporate bond sector are traded on the open market, and have clear risk ratings and high levels of transparency.

China’s debt structure is therefore riskier than the U.S. equivalent, and worrisome due to its sheer size. As China’s economy declines over the short run, which corporates are at risk of loan default?

Access to bank, trust and entrusted loans has increased China’s level of corporate debt and leverage ratios, with corporate bond issuance remaining at a minimal level. While bank loans in China have tended to be extended to large and midsize firms, and particularly to state-owned firms, trust and entrusted loans have been extended to firms of more varied size and ownership structures. Some of these latter entities have riskier business models and fundamentals. They often lack a well-established credit history of sufficient collateral, and sometimes even lack a strong underlying business model. Across both the banking and shadow banking sectors, industries with the highest leverage ratios include the real estate, metal and mining/steel, infrastructure, and construction industries.

Private firms are most at risk in the face of potential loan deterioration, particularly within industries with high leverage ratios. In the face of underdeveloped bankruptcy resolution, Chinese firms are encouraged to work out their debts as best they can. State-owned firms have a clear advantage – firms backed by the state may receive capital injections in the form of new bank loans, while bank loans that have turned nonperforming can be pulled of the books of the largest state-owned banks and purchased by asset management companies. By contrast, private firms do not have such a luxury. Firms that have faced default in recent months have mainly been private firms; examples are Zhejiang Xingrun Properties, which defaulted in March on RMB3.5 billion ($562 million) in bank and other debt, and Shanghai Chaori Solar Energy Science and Technology Co, which defaulted in March on an RMB4 million bond coupon payment.

More in the the Diplomat.

Sara Hsu is a speaker at the China Speakers Bureau. Do you need her at your meeting or conference? Do get in touch or fill in our speakers´ request form.

Are you looking for more financial experts at the China Speakers Bureau? Do check out our recent list here.

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Property downturn: what are the effects? - Sara Hsu

+Sara Hsu 

Whether China property bubble is popping, or more slowly evaporating, the effects on its economy will be enormous. Financial analyst Sara Hsu lists three of the most important effects for The Diplomat. She predicts no crash, but very serious effects indeed.

Sara Hsu:

First, and most directly, demand for manufactured construction materials like steel beams, as well as construction services will continue to decline. The construction industry alone employed more than 13 percent of the urban work force in 2012 according to the National Bureau of Statistics. This will have knock-on effects through the economy as workers lose wages and are unable to maintain current levels of consumption. This means that as consumption by laid off workers declines, industries that usually receive the benefits of their spending (such as grocery shops and retail outlets) will suffer through the multiplier effect and will be forced in turn to contract their spending too.

Second, real estate asset price declines will have an impact on household savings. As Nicholas Borst of the Peterson Institute points out, household wealth will decline as real estate values fall, as real property is viewed as an investment, leading to a decline in consumption given the negative shock to households’ holdings. This will further exacerbate the downturn in consumption caused by declining wages, with a net effect of reducing household standards of living and potentially generating social discontent. What is more, the drop-off in consumption comes at a time when the leadership is attempting to ramp up consumption in order to move away from the current investment-led model of growth.

Third, as real estate developers continue to find themselves unable to sell their properties, they will default on loans from various sources. Property developers borrowed heavily from banks until regulatory authorities warned banks in 2012 that there may be losses in the real estate sector, after which bank loans to property developers and local government financing vehicles were restricted. Property developers turned to trust companies and other shadow banking entities to obtain funding. Recently regulators have warned shadow banking entities such as trust companies to restrict lending to the real estate sector, but at this time the move appears to be too late to prevent financial fallout. In the short run, liquidity issues will likely present a real problem to the shadow banking sector and to some components of the banking sector. If liquidity issues become severe, solvency of shadow banking entities like trust companies and third party entrusted lenders may pose a problem. Middle class households that purchased wealth management products through banks and securities companies containing shadow banking loans will likely be outraged if payments are defaulted on, if recent history is any guide. This may provide yet another source of social unrest.

More in the Diplomat.

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Chongqing's wealth based on sky-high debts - Victor Shih

Victor Shih

Disposed Chongqing leader Bo Xilai might have left behind a more prosperous city, that wealth comes at a price, as Chongqing's debts are far higher than China's average of already high liabilities, tells financial expert Victor Shih in the Wall Street Journal.

The Wall Street Journal:

Those debts likely represent only part of Chongqing's obligations, analysts say, because state-owned enterprises and property developers have liabilities of their own. The figures also exclude a number of smaller investment vehicles. 

"I don't think it would be a stretch to say that Chongqing local government, state-owned enterprises and state-owned developers collectively owed 1 trillion yuan at the end of 2011," says Victor Shih, an expert on China's local-government debt at Northwestern University. That estimate, based on Mr. Shih's own look through the records of Chongqing's financing vehicles, would put local-government debt in Chongqing at 100% of gross regional product, far higher than the 22% level for China as a whole, according to numbers from China's national audit office.

More in the Wall Street Journal

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers' request form.

More on Victor Shih and China's debts at Storify.

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Capital flight "black swan scenario" for China - Victor Shih

Victor Shih

Europe might be looking at China as its financial savior, but China is really struggling to deal with its own debts, says financial analyst Victor Shih in Money Morning Australia. Capital flight is a serious risk, but only a worst-case scenario, he adds.

Money Morning:

Victor Shih, a political economics from Northwestern University in the US, estimates the Chinese banking system could handle half a trillion dollars due to capital flight. 

But should it continue, Shih anticipates up to a trillion dollars could leave China’s grasp and see the government lower the RRR to 5% or 6% to combat the lack of cash left at the banks. 

This means for now, China has a ‘cushion’ of roughly a trillion US dollars. That’s a lot of money. It’s the equivalent to 15% of China’s yearly gross domestic product. 

However he predicts the real problem, is those who follow the ‘smart money’, China’s wealthiest 1%: 

‘Sizeable outflows from the smart money would see the remaining 9% of top 10% of households follow the smart money.’ 

Meaning, if the rich see the super-rich moving their assets out of the country, they’ll quickly follow suit. 

This exodus of cash could potentially cripple the Chinese banking system. Simply because the loans in Chinese banks don’t really have an end date. They’re either paid or not. So banks constantly ‘roll over’ bad debts. According to Shih: 

‘A lot of loans in China are in reality non performing, they just get rolled over, time and time again, so they don’t ever get paid back. So you have a deposit base shrinking and on the asset side the loans are still there which means after a while you have illiquid banks.’ 

And should this happen, Shih reckons China’s authorities won’t be able to save China’s banks and recapitalise them.  

‘China can’t liquidate its entire $3 trillion foreign exchange portfolio… some of it is already invested in Chinese banks and Chinese institutions.’ ‘Chinese bank share prices would completely collapse if the Foreign exchange itself began to sell Chinese bank shares…’ 

But Shih is quick to point out that a capital flight of this level is more a black swan type of event. He says, ‘It’s a tail risk, but one investors should be aware of.’

More in Money Morning Australia

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers' request form.

More on Victor Shih and China's debts at storify. 

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If China helps Europe, only behind the scenes - Victor Shih

Victor Shih

Is China able and willing to bail out Europe? Political and financial analyst Victor Shih does not exclude the possibility, but he tells in Global Post, if China does so, it is not going to boast about it in public. What are the effects of China's own debt problems on the world?

Victor Shih in The Global Post:

The slow down in local government borrowing has led to a slow down in Chinese imports of construction materials. That mainly effects Australia, Brazil and other countries that export raw materials to China.  

On the contrary, the U.S. has really benefited from food inflation in China. Farmers have been driven off their land, when it is converted into real estate. Chinese dependence on imported food, especially from North and South America, has increased quite substantially in recent years. I don't see that trend reversing any time soon. So farmers in the U.S. have really benefited from Chinese growth and from rapid and artificially-driven pace of urbanization. 

This week, French President Nicolas Sarkozy appealed to his Chinese counterpart, Hu Jintao, for financing to support the euro zone's bailout. Does China have the money to do this? There are, after all, a lot of poor people in China, and development has a long way to go. And what are the risks of such financing for Europe and China? 

China has the world's largest foreign exchange reserves, and so strictly speaking they have the money to invest in whatever sort of bailout scheme Europe comes up with. At the same time, I think Chinese leaders are very careful not to publicly claim credit for saving Europe. That's because, although in the short-term there could be some pay-off, there are still risks and we don't know what really is going to happen to Europe down the road. If this bailout has to be followed by subsequent bailouts, then it's not going to look very good for the Chinese decision makers. So I think they'll go about it in a careful way, and it will largely go unseen by the public.

More in The Global Post, also about the Wenzhou private lending bubble and China's other debts.

 Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch, or fill in our speakers' request form.

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More land sales needed to repay debts - Victor Shih

Victor Shih

China's local government have been financing their wealth mostly by selling off land. As debts to fuel economic growth rise, more land sales might be on the agenda, tells financial and political analyst Victor Shih in Bloomberg, increasing the gap between rich and poor.

Bloomberg:

Cities may have to accelerate land sales as they struggle to repay the debt, said Victor Shih, a professor at Northwestern University in Evanston, Illinois, who studies China’s local- government finances. There’s also an incentive for officials to keep payments to farmers as low as possible, he said. 

“Without suppressing land compensation, local governments can’t make the margins to pay back the banks,” Shih said. “In essence, they are the engines of inequality in China. Land development is the redistribution of income from average households to rich households.”

More in Bloomberg

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch, or fill in our speakers' request form.

Victor Shih and China's debts.

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Pay back time for the Beijing Olympics - Victor Shih

Victor Shih

Bonds from 15 local government agencies worth US$ 2.5 billions to finance the Beijing Olympics are due, and financial and political analyst Victor Shih tells Bloomberg that is reason enough to keep a close eye on how China is going to pay back its debts. Bloomberg:

“The Olympics was a spectacular event for China, but now Beijing has to deal with the hangover because of high borrowing to finance the event,” said Victor Shih, a professor at Northwestern University in Evanston, Illinois who analyzes China’s local government finances. “Bond yields are heading up, so refinancing will be much more costly.” The yield top-rated companies must pay on 10-year bonds has risen 74 basis points, or 0.74 percentage point, this year to 5.88 percent and touched 5.92 percent on Aug. 4, according to Chinabond data. Borrowing costs for similarly ranked U.S. companies have dropped 84 basis points to 3.12 percent in the same period, Bloomberg data show... “Beijing runs perennial budget deficits like most other cities in China, which means any sizable bond redemption would put a severe strain on the city’s budget,” Shih said by e-mail. Authorities will “need to be very inventive in repaying the coming waves of redemptions.”... Investors “should pay close attention” to what strategy Beijing takes as it tackles its debt burden, according to Northwestern University’s Shih. It may involve “stripping cash-generating assets from the city’s other state-owned enterprises to help restructure the debt,” he said. “But when this is done, people continue to borrow and the pool of illiquid loans gets larger and more unknown.”

More at Bloomberg Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch.

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China tied by debt and inflation - Shaun Rein

Shaun Rein by Fantake via FlickrChina will not be able to play a role in mitigating a new financial crisis, like it did in 2008 at the first dip, writes business analyst Shaun Rein in CNBC. Sky-high debts and a stiff inflation rate limit the country's room

In CNBC:

Three years later, total local government debt alone is 10.7 trillion yuan, around 27 percent of GDP according to Jia Kang, the director of the Research Institute for Fiscal Science under the Ministry of Finance. Concerns about off-balance sheet debt held by special investment vehicles set up by local governments that don’t show up as public debt are also high. China's debt is far from dangerous, Japan’s debt was 225.8 percent in 2010 according to the IMF, but is high enough to mean less room to maneuver than in 2008.
More importantly, China has less wiggle room because of persistent and structural inflation and the government's desire to create a middle class by raising minimum wages. Already in 2011, 13 provinces have raised the minimum wage by over 20 percent.
Chinese inflation is not at the 20 percent annual level hitting Vietnam, but it is at the cusp of becoming a serious problem. One more natural disaster like the tsunami in Japan or a war on the Korean peninsula could turn China's inflation into something along the lines of Vietnam's.
Official Inflation in China came in at 6.5 percent in July, despite price caps in the oil sector.Food inflation is far more serious at 10-15 percent. Pork prices, the main meat staple for Chinese, has risen 50 percent in the last year. Apple prices have gone up 30 percent and yogurt 25 percent.

More in CNBC

Shaun Rein is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch.

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Credit crunch leads to slowdown - Victor Shih

Credits by Chinese banks are on a leash, cashing a slowdown in China's breakneck growth speed. Financial and political analyst Victor Shih explains in Business Week how that works out.

Business Week:

Victor Shih, a political scientist at Northwestern University who studies the local debt problem, says the banks are reacting to poor returns on their investments in everything from real estate to subway lines. “Banks’ focus now is to use existing credit to ensure loans don’t go into default,” says Shih. “That makes credit to new projects more difficult—one reason we are seeing a slowdown.”

Moody’s estimates that 8 percent to 12 percent of China’s total loan portfolio could be nonperforming: The official figure is 1.2 percent. Earlier this year, Fitch Ratings warned that nonperforming loans could reach as high as 30 percent. Especially vulnerable are small businesses. They account for 80 percent of employment, according to China’s Ministry of Industry and Information Technology, yet struggle to get credit.

More about the credit crunch in Business Week.

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch.

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mailto:fons.tuinstra@china-speakers-bureau.com

The political risks of China's debts - Victor Shih

Victor Shih

Social instability and a touchy change of power in 2012 are just two of a set of stinging problems China's sky-high debts is causing the country, political analyst Victor Shih tells the Global Post in an extensive interview on the country's shortfall. Some quotes:

Americans probably wouldn't be hurt that much. Some people worry that if there's a debt bubble that somehow bursts, then China will redeem its large holding of U.S. Treasuries to bail out Chinese banks. That is a possibility. I think that if that were the case, others would snap up those Treasuries. Interest rates may go up a little bit, but probably not by that much.

As for the Chinese government, the current leadership steps down from power next year. They don't want to look bad by revealing that they got China into so much debt. On the other hand, the new leaders will want to do more to reveal the problem, because otherwise there's some risk that they will be blamed. So we do see this kind of conflicting tendency within the Chinese government to disclose how much local debt there is....

The downside of all this debt, it seems, is that the government's legitimacy depends on its ability to continually improve the standard of living of its people. Could inflation and debt provoke instability in China?

There is already a huge amount of instability in China. There have been 80,000 mass incidents, some of them are very peaceful sit-ins, but there are thousands of riots in China. But all of these incidents have been very isolated to one or two places, there has not been any sort of inter-regional unrest.

When you have such a powerful apparatus to maintain control, why do you need legitimacy?

Some Arab governments these days may have a tough time with that question.

The Chinese government would say that that's because they allowed social media to operate freely, which is not the case in China.

More in The Global Post

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch.

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China can deal with its sky-high debts - Victor Shih

Victor Shih

China's debts could be as high as 150% of its GDP, higher than that of the US and Greece, says political analyst Victor Shih in Aljazeera. But is should reform its inefficient economy to deal with that debt.

The official numbers of China's aggregated debts vary a lot, but could be as high as 1.65 trillion US dollar. How can the country then still promise to buy up much of the European debt? China's largest problem is not the amount of debts, since it also has a huge deficit with other countries, but the way is has organized its economy, says Victor Shih. "Much of the control has been decentralized to local governments."

Also, much of the economy is dominated by State-Owned companies, who are still making nice money. But when they would default, the burden would be on the government. Lacking financial reform is a bigger problem than the debts, according to Shih.

More in Aljazeera.

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch.

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China's local debts still higher than officially estimated - Victor Shih

Victor Shih

China's financial institutions have been releasing assessments on the total of debts local governments have, writes Victor Shih in a guest blog at the Financial Times. But they are not yet close to the real debts of 15 to 20 trillion Renminbi.

Here is how we arrive at these numbers. First of all, we have to understand that the National Audit Office is like the Congressional Budget Office and only cares about debt directly owed by local government organs or debt directly guaranteed by local government organs.

It does NOT care about liabilities of central and local governmental entities, which were not guaranteed by the government. Chart 3 of the report states that the audit uncovered Rmb4,970bn in local government financing vehicle (LGFV) debt as of the end of 2010, and another Rmb5,700bn or so owed by local government organs and “business units subsidised by the budget.”

However, based on the figures previously released by the CBRC and the PBOC, we know that the Rmb4,970bn LGFV debt figure is way too low. The discrepancy between the CBRC and PBOC estimates and the NAO number arises from the fact that the NAO was only looking for LGFV debt in which the local government has issued decrees or guarantees to underwrite. Thus, LGFV debt which is guaranteed by another company or is collateralised by land was not part of the NAO audit.

More analysis from Victor Shih in the Financial Times

Victor Shih is a speaker at the China Speakers Bureau. When you need him at your meeting or conference, do get in touch.

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China is hiding, not solving its financial problems - Victor Shih

Victor Shih

China bear Victor Shih explains Medill Reports from Chicago why China's growing debts are getting out of hand, despite efforts by the financial authorities to act on the growing concerns. It's a wash, he claims.

The prudential tightening being undertaken by China’s central bank has not been very effective, he said. China’s central bank is increasing reserve requirement ratios while also buying bonds from the market. “If you put the two things side-by-side, they are a wash,” Shih said.

“In fact, money supply has risen substantially since late last year. It’s growing at a 17 percent” annual pace, he added.

According to Shih, the reason behind the conflicting measures is that there are a lot of nonperforming loans sitting on the banks’ balance sheets, which “they are trying to hide.” One classic way of hiding those bad loans is to allow the banks to roll the loans over.

And this is happening on a large scale in China.

From a bank's perspective, this is not a trivial event. If borrowers couldn't repay their loans, soon the bank would find itself strapped for cash to make new loans.

Shih said the only way to keep the whole thing going with "rising illiquidity on balance sheets" is to increase the money supply, which is what the government has done in order to keep banks lending.

This is why there continues to be inflationary pressure in the country, he explained.

“This problem will continue to haunt China,” Shih said. “There will continue to be, maybe not super-high inflation, but an uncomfortable level of inflation.”

More in Medill Reports.

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch.

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What about the underground financial bubble? - Victor Shih

Victor Shih

Victor Shih of the Northwestern University has been doing much of the legwork to find out how much China's debt actually is, much higher than China's financial authorities want to admit, he writes on this blog of the Financial Times. Much of the country's financial bubble remains underground.

At the end of April, Baotou-based Chinese billionaire Jin Libin set himself on fire to escape his creditors.  His method of dealing with the situation was disturbing enough, but the structure of his debt was equally shocking. Investigators found that his billion renminbi business owed banks only 150 million RMB, but owed individual creditors and informal banks Rmb1.23bn.

In other words, he owed private creditors and informal banks over eight times what he owed the banks. Although extreme, Jin’s debt situation suggests a highly risky debt bubble that seems to be growing without much control outside of the banking system.

More in the blog of the Financial Times.

Victor Shih is a speaker at the China Speakers Bureau. When you need him at your meeting or conference, do get in touch.

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China: less of a miracle - Victor Shih

Victor Shih by Fantake via Flickr

China's three trillion US dollar of foreign reserves and other assets might look impressive, but when you withdraw the country's debts and other liabilities, it looks no longer that special, tells Victor Shih at the US-China Institute. Local companies and governments hold those debts.

Victor Shih is a speaker at the China Speakers Bureau. Do you need him at your meeting of conference? Do get in touch.

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