Chinese markets were roiled by the country’s first-ever domestic bond default and a litany of minor bankruptcies that has put into focus China’s troubled, but little understood, banking system.
Typically tight-lipped about its financial stumbles, the Chinese state-controlled media has been unusually forthcoming about the defaults, publishing the details candidly, almost as if the coverage was part of a public campaign. Some experts believe China is publicizing, even exaggerating, the defaults as a way to chasten unruly markets and reimpose financial discipline in the private sector.
Still, however hyperbolic Chinese media coverage, the default and bankruptcies are real, and collectively signify a growing problem in China’s banking industry. In the last several years, Chinese growth is largely fueled by the accumulation of credit, which, over the last five years alone, is approximately equal to the monetary value of the entire U.S. banking industry. China’s total debt as a percentage of GDP, a key metric for gauging a country’s fiscal health, ballooned to 220 percent from just 130 percent in 2008.
China’s household and corporate debt have simultaneously skyrocketed, from a manageable 120% of gross domestic product to an unsettling 170 percent, not including debts still owed by financial companies. By way of comparison, the U.S. experienced a massive credit boom that saw a leap from 143 percent in 2001 to 177 percent in 2008. Japan, too, underwent similar transformations leading up to its virtual collapse in 1989.
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Mark Williams, chief Asia economist for Capital Economics, remarked, “I don’t know any country that’s seen such a large increase in debt and not gone on to have some form of crisis.”
The root cause of China’s looming credit problem seems to be the banking system. A variety of specialty financial products have permitted China’s banks to continue robust lending policies despite regulatory attempts to dampen their enthusiasm. And it’s not always clear the banks don’t actually operate with their implicit imprimatur. Jaspal Bindra, Asia chief for Standard Chartered, said, “The shadow banking thing has been both known and blessed for a long time. Then I think that people have taken to a point where it’s been abused.”
The Chinese government has recently resorted to some very public interventions in order to reign in rogue lending and calm investor fears. For example, the Chinese Development Bank shut down a generous lending program maintained with a Bangladesh telecom company, citing overextension.
It’s almost impossible to determine how much of China’s credit is generated by this “shadow banking” system given that so many loans are dispensed hidden from publicly accessible balance sheets. But the concern about these loans are no longer clandestine. Bindra noted, “They were very aware and very public. It wasn’t a whisper in my ear or a secret or something. They were probably telling everybody who visited them to make their point that they know what is happening.”
Many experts have drawn parallels between China’s impending crisis and Japan’s past collapse. Japan, too, was saddled with swelling real estate prices and mounting debt, all fueled by a banking sector that had grown far too promiscuous with its increasingly reckless borrowers. Once the debts soured and the Japanese government initially dithered, the banks were left sorely undercapitalized, unable to lend, stymieing real economic growth. Just as might be the case with China, “no systemic financial crisis occurred, but financial stress was hidden,” said Haibin Zhu, J.P. Morgan’s chief Asia economist.
And China’s case might even be worse. Haibin Zhu warned, “The consequences could be more severe for China. China is not as wealthy as Japan was and so would not be able to sustain as much stress.”
The problem could be more widespread for China than for Japan since the state owns the banks. Bindra said, “The difference I think is the over-leveraging, if at all in China, is all one pocket of the state.”
It’s almost impossible to tell precisely how deeply infected China’s banking system is with underlying sickness. Officially promulgated data supports a story of general growth sustained by strident consumer confidence. However, consumer data spins a different tale of instability, and a crumbling financial sector. Analysts, though, are in agreement that a Chinese financial shock of the kind Japan experienced in 1989 would have global, and potentially catastrophic, consequences.
Also, China’s metastasizing credit disease is likely to have big implications for the apparel industry. According to J Capital Research (JCR), sales dropped considerably toward the end of 2013. Anne Stevenson-Yang, JCR analyst, said, “Durable goods appear to be stacking up in warehouses all over the country, a phenomenon that illustrates some of the distorting effects of engorging an economy on credit.” In other words, since credit is so readily available at bargain basement prices, brand owners feel free to manufacture more product that can be expected to sell.
One problem this inventory glut papers over is that there is a wide disparity between China’s reported retail sales figures and the health of its domestic consumerism. It’s instructive to note that its National Bureau of Statistics (NBS) counts products as they are shipped from the factory rather than when actually sold. So, despite mounting evidence of consumer inactivity, the NBS continues to report vigorous growth.
According to a spokesperson from China Lilang, a prominent retailer in Beijing, “Consumer sentiment showed no sign of significant recovery, affecting many businesses.” An even stronger indictment of the situation was delivered by a representative from Belle International Holdings, “The reality behind the numbers is gloomier.”
The more telling statistics reveal aggressive household savings bordering on national cash hoarding. The average Chinese household saved a eye-opening 38 percent of its disposable income in 2013, a massive jump from the norm of about 20 percent that held throughout much of the 1990’s. The spokesperson from Belle International weighed in, “As a defensive reaction, consumers are becoming more inclined to save and less willing to spend.” James Roy, analyst at Consultancy China Market Research Group, concurred, “Their sentiment and confidence is very negative from what we found and so that is going to hurt some of the mid-tier consumer retail brands.”
And this is the sort of problem that conceals itself beneath a patina of good news. The initial consequence of overproduction is that it creates the illusion of growth. Many analysts contend that the true impact of unsold inventory might take a year to take full effect.