October 4th, 2012
Written by Gavin Kakol, GEI Associate
Our greatest foreign creditor, China, is continuing to show signs of an economic slowdown. Not only has manufacturing been contracting, but the Renminbi has become a scarce commodity among the private sector. The newly developing liquidity crisis is leaving China’s banks strapped for cash. Meanwhile, factories and incomplete projects are seeking short term loans just to survive. In an export driven economy such as China’s, a lack of immediate cash flows is ruinous; however, debtors have not been repaying with an equal sense of urgency.
Current projects are struggling to finish, and when funding is available, perhaps the central government is the driving force behind the loans they do receive, which are increasingly short term. Data from Bernstein Research Group in Hong Kong shows us that short term loans have been on the rise since mid-2010 while long term loans have steadily declined as a share of the market.
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According to Paul Davis of the financial times:
The received wisdom is that banks do not want to lend in the current environment, but they are clearly coming under pressure from companies, perhaps with high inventories or part-finished projects, that are crying out for short-term money to keep operations ticking over.
However, Patrick Chavonec, an Associate Professor Tsinghua University’s School of Economics and Management, notes that the central government may actually be pressuring Chinese banks to lend, even if the recipients were on prior months' “do not lend lists”.
So why is one of the World’s largest creditors so low on cash?
Many of China’s foreign loans have yet to be repaid, perhaps some never will be. The China Banking Regulatory Commission claims its nonperforming debt ratio is 0.9 percent. Yet the commission itself has been expressing some doubts over the figure. In June the commission released the following statement:
We are already aware of an obvious increase in overdue loans and 'special-mention' loans. Further statistics and analysis are necessary for us to discover the cause of the inconsistency and how much hidden risk there is.
The Fitch Rating Agency notes the 0.9 percent figure to be” vastly understated”. Using an eighteen month stress test, Moody’s has determined that Chinese banks will be able to handle non-performing loans as long as the economy’s GDP growth remains near 7 percent. If growth were to slip below five percent the banking system could be facing a non-performing ratio of nearly 20 percent.
The South China Post newspaper has recently discussed how overseas loan repayment delays have increased from sixty to ninety days. The additional time lapse starves overseas suppliers of the necessary cash flow to continue paying their raw material producers. Basically, stretched debt repayments have a trickle-down effect throughout the entire Chinese economy.
In a market dominated by exports, any cash delays are tough to endure. Furthering the problem, the world economy has reduced its purchase of Chinese exports. According to an independent study discussed in Bloomberg, China’s manufacturing has declined for eleven straight months; contract purchases have declined five straight months and “orders received“ have fallen to the lowest levels in nearly four years. Gei News has reported on the eleven consecutive months that the HSNC Flash PMI Index has been below 50, the value that marks the boundary between expansion and contraction.
To induce more liquidity into China’s economy, the People's Bank of China has cut reserve requirements twice this year- they now stand at 20 percent. For months now, the central bank has been injecting billions of Yuan into its money market using reverse repurchase agreements; the most recent round came September 25 when a record breaking 290 Billion Yuan ($46 billion) were introduced.
These liquidity injections have effectively lowered the interest rate, cutting the yield on treasury bonds. The yield on the 2.95 percent 2017 government bond dropped five basis points to its now standing 3.23 percent yield.
The drop in bond yields has increased the demand for stocks. Chinese markets responded accordingly late in the previous week of trading as stocks rallied for two days of strong gains. The Shanghai and Shenzhen indexes finished Friday off up 1.45 and 2.27 percent respectively. The strongest stock advances came in the banking and metal sectors.
Chinese stock exchanges have been on holiday the past week. Meanwhile, China’s 25 Index Fund (FXI) has been trading around $34. The index is a compilation of China’s 25 largest most liquid companies available to international investors.
Just as in the U.S. experience, it appears that China also can see asset appreciation when actions are taken to improve liquidity in the real economy.
- (China’s Central Bank Injects Record Funds to Ease Cash Crunch, Judy Chen, Bloomberg News, 25 September 2012)
- Articles about China (GEI News)