【The Telegraph】China's banks may have a tiger by the tail

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China's banks may have a tiger by the tail      
http://business.theage.com.au/business/chinas-banks-may-have-a-tiger-by-the-tail-20090630-d3v6.html

July 1, 2009

               
Illustration: Spooner

CHINESE banks are veering out of control. The half-reformed economy of the People's Republic cannot absorb the $US1000 billion ($A1231 billion) in new lending issued since December. Money is leaking instead into Shanghai's stock casino, or being used to keep bankrupt builders on life support. It is doing little to help lift the world economy out of slump.

Fitch Ratings has been warning for some time that China's lenders are wading into dangerous waters, but its latest report is even grimmer than pessimists had suspected.

"With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary," it said.

"Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear."

Note the phrase "able to bear". Fitch's "macro-prudential risk" indicator for China threatens to jump from category one (safe) to category three (Iceland, et al). This is a surprise to me but Michael Pettis from Beijing University says China's public debt may be as high as 50-70 per cent of GDP when "correctly counted".

The regime is so hell-bent on meeting its growth target of 8 per cent, it has given banks an implicit guarantee for what Fitch calls a "massive lending spree".

Bank exposure to corporate debt has reached $US4200 billion. It is rising at a 30 per cent rate, even as profits contract at a 35 per cent rate.

Fitch traces the 2009 bubble to the central bank's decision to cut interest on reserves to 0.72 per cent. Bankers responded to this "margin squeeze" by ramping up the volume of lending instead. More than half the new debt is short-term. Roll-over risk is rocketing. China's monetary stimulus since November is arguably more extreme than the post-Lehman printing of the United States Federal Reserve, though less obvious to the untrained eye.

Under the Taylor rule, US policy remains tight (for the US). China's policy is loose (for China). New loans doubled in May from a year earlier, almost entirely to companies.

China's Banking Regulatory Commission fired a warning shot last week. "The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy," it said.

Unfortunately, 40 per cent of the "real economy" consists of exports, mostly to the US and Europe, the consequence of a mercantilist export model that has crashed and burned. Chinese exports were down 26 per cent in May.

World trade may be stabilising at last after contracting at faster rate than during the early Great Depression.

But it will not rebound fast in a world where the US savings rate has risen to a 15-year high of 6.9 per cent. A trade policy based on the assumption debtors in the Anglo-sphere and Europe's Club Med can ruin themselves forever is absurd.

Andy Xie, a Sino-bear and commentator for Caijing, said Western analysts are in for a rude shock if they think China's surging demand for raw materials implies genuine recovery. Commodity speculators have been using cheap credit to play the arbitrage spread between futures and spot on the oil markets. They have even found ways to trade lumber to iron ore by sheer scale of leverage. Mr Xie thinks the spring recovery is an inventory spike, to be followed by a double-dip downturn into next year.

Reformers know what must be done to increase consumption. China needs a welfare revolution. But creating a social security net takes time, and Beijing is facing a social crisis as 20 million unemployed retreat to the rural hinterland.

So the regime is resorting to hazardous methods to keep excess factories humming: issuing a "Buy China" decree: using export subsidies; holding down the price of coke, bauxite, zinc and other resources to lower production costs; and suppressing the yuan, again. Protectionism is a risky game for a country that lives off global trade and runs a surplus near 10 per cent of GDP.

While the Shanghai composite index is up 70 per cent since November, Chinese imports are down 25 per cent from a year ago. China is still draining real stimulus from the global economy.

If the world's biggest surplus state ($US400 billion) is too structurally deformed to help offset demand shock as Western debtors retrench, we are trapped in a long deflation slump.

Ambrose Evans-Pritchard is international business editor of the Telegraph.

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