Why You Should be Skeptical of Chinese Debt Reform

Every time China holds some blue sky political confab and all the press releases or reports talk breathlessly about reforms, I always counsel: wait until you see it.  Do not believe the PR.

People have raised the issue about why I am so deeply cynical about claims of reform.  So rather than write a lengthy missive complete with mountains of data about how China is absolutely not deleveraging, I decided to put together a collection of articles that talk about all the “reform” related to debt.

Couple of quick points. First, this was done using a basic Google search specifying time ranges with either “China debt” or “China deleverage” as deleverage did not enter the lexicon until 2015. Second, I do not mean to impugn the journalists that might have written these pieces as they are consciously trying to report on both sides.  Third, I have chosen sections that talk about “reform” in these areas.  There is some skewing of the overall piece in most cases as they tend to be more balanced, but many cling fast to the idea that there is some type of “reform” going on.

China has been talking about “reform”, controlling debt, deleveraging, and related matters for many years and still nothing changes.  Do not believe the PR until you see it in action.

2012:

The Diplomat: When the Chinese Central Bank (the People’s Bank of China) and banking regulators sounded the alarm in late 2010, it was already too late.  By that time, local governments had taken advantage of loose credit to amass a mountain of debt, most of it squandered on prestige projects or economically wasteful investments.  The National Audit Office of China acknowledged in June 2011 that local government debt totaled 10.7 trillion yuan (U.S. $1.7 trillion) at the end of 2010.

South China Morning Post: the government must not lose sight of these reforms, including liberalisation of the banking sector, so that private capital and enterprise can play a greater role.

Bloomberg: Yet shuttering the excess production lines may not happen anytime soon. “All the big producers have strong backing from the state banks. That is why they have been adding new capacity. This is not a commercial decision but a political one,” says UOB’s Lau. It’s happening because “the government wants to boost local economies.”

China Daily: Liu Yuhui, director of the financial lab at the Chinese Academy of Social Sciences, said: “Apparently a wide range of debt restructuring cannot be avoided. This time, the debt issue has prevailed across all areas of the economy. Adding long-term use of allied borrowing – which means a group of companies make guarantees to each other when applying for loans together – can lead to very high systemic risk,” Liu said.

People’s Daily: “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,” said the source from the China Banking Regulatory Commission, who declined to be identified.

2013:

Reuters: “China’s government debt risks are in general under control, but some areas have certain dangers,” the state auditor said.

The Diplomat: However, there was also a special focus on the issue of local government debt, which has been weighing on the minds of some observers for years already. According to the statement (available here in Chinese) released after the conference, “controlling and defusing” local government debt risks will be an “important economic task” for the coming year.

Peterson Institute: Deleveraging is the priority in solving the local government debts.

Wall Street Journal: Worried that borrowing may be out of control, the leadership has instructed the National Audit Office to do a comprehensive survey of all the official borrowing out there

New York Times: Beijing’s eagerness to combat financial risks and bring about more efficient and disciplined allocation of capital will mean slower growth and possibly isolated loan defaults in the coming years, analysts like Mr. Zhang say.

Carnegie Endowment: China’s leaders demonstrated that they realize change is needed in November 2013 at the Third Plenum meeting, when they laid out a comprehensive plan for reforming the economy.

2014:

The Diplomat: “…how the deleveraging process unfolds will be closely tied to the increased regulation or winding down of shadow banking subsectors.”

Globe and Mail: “Chief economist of Denmark’s Saxo Bank, Steen Jakobsen, like Mr. Magnus, thinks that the Chinese government will deflate the credit bubble by allowing some defaults and bankruptcies – capital destruction, in other words – and attempting to reform SOEs and local governments. The process, of course, will remove some momentum from economic growth. The question is by how much.”

Deutsche Welle: Yukon Huang “If the government then introduces appropriate reforms, it can probably push growth back up to 7 percent, may be even 7.5 percent, for the rest of the decade and beyond. But that implies the implementation of basic structural reforms as outlined in the third plenary session of the Communist Party’s Central Committee.”

China Daily: Most importantly, money is not the solution – especially when the local government debt, which totaled 20 trillion yuan at the end of 2013, may snowball if unregulated and cause a crushing threat to the whole economy. What the economy needs to do, and has been doing since last year, is to deleverage whenever it can to reduce risks and protect its financial industry.

2015:

China Daily: An executive meeting of the State Council presided over by Premier Li Keqiang on Wednesday decided to speed up the restructuring of “zombie enterprises” to encourage the market-oriented allocation of resources, a statement released after the meeting said.

Bloomberg: President Xi Jinping’s government aims to wind down that burden to more manageable levels by recapitalizing banks, overhauling local finances and removing implicit guarantees for corporate borrowing that once helped struggling companies. Those like Baoding Tianwei Group Co., a power-equipment maker that Tuesday became China’s first state-owned enterprise to default on domestic debt.

The Economist: It is not too late for China to bring its debts under control. Regulators have taken steps in the right direction. They have obliged local governments to provide better data on their debts and have forced banks to bring more of their shadow loans onto their balance-sheets, providing a clearer picture of liabilities. One reason that banks have been issuing loans so quickly this year—faster than overall credit growth—is that they are replacing shadowier forms of financing. China has also used both monetary easing and a giant bond-swap programme for local governments to reduce the cost of servicing debts.

Matthews Asia: the medicine for this problem will be another round of serious SOE reform—including closing the least efficient, dirtiest and most indebted state firms in sectors such as steel and cement—rather than broad deleveraging, leaving healthier, private SMEs with room to grow. In contrast to the experience in the West after the Global Financial Crisis, cleaning up China’s debt problem should actually improve access to capital for the SMEs that drive growth in jobs and wealth.

Xinhua: Facing the arduous task of structural reforms, five major tasks were identified — cutting excessive industrial capacity; destocking; de-leveraging; lowering corporate costs; and improving weak links.

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