The Great Wall of China dates from the 7th century BC and is over 20,000 km in length.
It has had a profound military, economic and political impact on China. But at times of global financial crisis, China also seems to have had a financial “great wall” protecting it from contagion. China’s economy in the 80’s. 90’s and the start of this century was posting growth rates in the 10% region despite regular global wobbles. Admittedly these rates have come down and currently the economy is operating at a run rate of about 5%.
So as we deal with our latest banking crisis it seems fair to ask: Is China immune? Is the financial Great Wall working?
Well, the people who watch these banking issues closely – the rating agencies – don’t really help us differentiate. Moody’s have a negative rating on Chinese Banks. But they rate US, UK and European banks equally negative.
We know there is plenty of debt.
Using a broad definition that adds official government borrowing along with debt run up by so-called local government financing vehicles and state policy banks, Goldman Sachs analysts estimate that the public burden has surged 10-fold over a decade. It reached $23 trillion last year, or 126% of GDP.
Property, where perhaps we have seen most stress and focus in the past 12 months, continues to require attention and Goldman expect increased default rates in property high yield bonds in 2023. The Evergrande saga appears to have reached some satisfactory conclusion. The property market experienced its “worst-ever slump” last year, with sales down 24 percent. The property sector, which along with construction accounts for about a quarter of China’s GDP, is a key pillar of the country’s growth.
Prices of new homes in China rose at the fastest pace in 21 months in March, in the latest sign of green shoots for the world’s second-biggest economy as it recovers from three years of pandemic restrictions. No one is forecasting or indeed looking for a return to exuberance but we may be entering a more steady cycle.
The recent banking concerns in the US originated in the smaller banks, and indeed regional banks as a sector are still 20-30% down so far this year. Is there comfort for investors in China’s large State owned Banks?
Small local banks actually account for a sizeable share of China’s banking assets.
The smallest of banks account for nearly $15 trillion in assets. This is more than half the size of the large Commercial Banks. These smaller banks are laden with non-performing loans and face difficulties attracting stable deposits.
But won’t the Central Bank step in, in any of difficulty?
Pre-pandemic, the authorities allowed Baoshang Bank be the first Chinese bank to go bankrupt in nearly two decades, wiping out bond holders and forcing a hair-cut on depositors. However we may take some comfort from Beijing’s more recent focus on financial stability.
Perhaps the financial threat could come from this side of the Great Wall.
China has been investing in roads, railways, ports and other infrastructure projects across 150 countries in Asia, Africa elsewhere over the past 10 years in it’s widely touted “Belt and Road” initiative (BRI).
There is no official figure for the scale of this spending but some analysts put it at around $1 trillion. However in the past three years, estimates are that about $80 billion has been written off or renegotiated, and the pace has been growing. China has also lent another $100 billion or so to prevent sovereign defaults. Estimates are that before the roll-out of BRI only 5% of Chinese overseas lending portfolio supported borrowers in financial distress; today that figures stands at 60%.
Given how closely BRI is associated with Xi Jinping, and its role in China’s international policy, it is difficult to see it being halted, but it may get fewer resources. In a world of higher interest rates, slow economic growth and record debt levels in the developing world, further write-offs are possible.
The risk of a banking crisis is top of mind with Chinese policy makers. This was clear at the recent party forum. The last ten years have seen greater power being accumulated by the centre. This applies to Banking and Financial Services as much as anything else. Xi’s view is that the financial sector should better serve the real economy, and has deepened structural reform to ensure this. Bank fraud in Henan Province last year was a strong catalyst for action.
A new all-encompassing financial regulator, the State Bureau of Financial Supervision and Administration, has just been set up to oversee the sector. Allies of Xi Jinping have been appointed to key regulatory roles. One of the key targets is to prevent domestic funds moving overseas.
In sum, China does have many of the ingredients that lead to our recent banking stress – large number of small banks, growing non-performing loans, singular focus on one asset – in China’s case, property.
Western Central Banks chose to ensure liquidity and force mergers in the recent crisis. This was reacting to the crises, rather than having the appropriate regulation in force. The US Federal Reserve in a report this week blamed SVB’s collapse on Trump-era rule changes that meant regulatory standards were too low and supervision lacked force.
China’s policy seems to be to “turbo-charge” their Regulator. It’s an ultra-cautious approach (similar to full lock down in the face of Covid 19) and remains to be seen how well this approach may work in a crisis.
Tradewinds 