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The latest dose of Chinese Realism was served up last weekend. As Jay Z once said, China's got 99 problems and a shiny new plan fixes none.
As usual, market headlines were full of speculation over China's GDP growth target and how much infrastructure they'd be building. The answers to both were 5%, and not as much as commodity bulls hoped.
The real answers? It doesn't matter. The bursting of the property bubble was the first domino, and the effects continue to ripple through the economy.
China's massive debt load is also being recognised, as highlighted here by Bloomberg 👇
More local government financing vehicles (LGFV's) in China may seek debt reprieves including maturity extensions this year, after authorities issued clearer instructions on how to defuse one of the nation’s top financial risks.
That’s the takeaway for analysts after Premier Li Keqiang highlighted regional governments’ debt pile as a key threat to financial stability alongside property woes in a key address Sunday to open China’s annual parliamentary meetings.
To achieve that, authorities must “improve the mix of debt maturities, reduce the burden of interest payments, and prevent a build up of new debts while working to reduce existing ones,” Li said.
Premier Li: “The era of excessive debt expansion by LGFVs is over”
The old model where local governments could 'self-finance' via ever increasing land sales during the property boom is long over.
This doesn't (necessarily) mean that local governments will become insolvent, but it does mean that growth may well be constrained as debt obligations take a large share of reduced government incomes.
Opacity of the under-developed banking system is a key concern too...
In a lovely circular deal, city banks lend to local governments (LGFV's). The banks hold the majority of these bonds on their books.
However, as the IMF point out in this 2018 report: Credit Booms - Is China different? there's a large maturity mismatch...
One particular risk is the sizable maturity mismatch between asset and liabilities. Most banks remain net borrowers in the interbank market, with maturities still hovering near the short end.
The maturities of their assets tend to be much longer, by comparison. Meanwhile, growing interlinkages suggest that a liquidity crunch could quickly spillover to the broader financial system.
For instance, the WMP (Wealth Management Product) business invests more than half of its assets in the fixed income markets. Bond market losses suffered by WMPs could lead to bank balance sheet stress given the widespread perception of implicit guarantees of banks’ sponsorship of WMPs.
Moreover, if a disruption to financing flows were to occur, not only could the borrower face liquidation pressure, the loss could cascade down the intermediation ladder, reaching other financial products and institutions including the broader banking sector.
Why is maturity mismatch a risk?
Maturity transformation can be risky: During the 2007-2008 financial crisis, the firms that were most stressed were those that relied on short-term, wholesale funding to finance portfolios of longer-term assets such as mortgage-backed securities.
When lenders got nervous about the value of those securities they pulled their funding, and the shadow bankers struggled to repay their investors.
A classic liquidity crunch.
Which is probably why the CBIRC (China Banking and Insurance Regulatory Commission) is being replaced by a larger, national financial regulator, just one of many changes intended to overhaul the status quo.
William Pesek has an excellent explanation here 👇
What’s abundantly clear, though, is that the economic team led by Xi’s choice as next premier, Li Qiang, is gearing up for a structural supply-side reform regimen sure to recalibrate China’s main growth engines.
That includes policies that encourage households to consume more and increase Chinese self-reliance amid US efforts to halt the flow of advanced technology to Xi’s economy.
It’s not like Xi’s predecessor Hu Jintao, who led from 2003 to 2013, didn’t know what upgrades were needed to raise China’s economic game. But powerful fiefdoms within party circles that exert extreme power over regulatory bodies have vested interests in protecting the status quo in China’s $60 trillion financial system. Students of Japan wondering why change in Asia’s No 2 economy seems so impossible will understand the parallels.
Rather than tolerate further infighting between China’s financial and banking regulators, Xi is creating an enlarged national regulator to get big things done. The powerful China Banking and Insurance Regulatory Commission is going to disappear, while the China Securities Regulatory Commission will get increased clout as it’s put directly under the State Council.
It's a beautiful dichotomy. The current model is unsustainable, reforms are required, and all of the usual 'promises to support XYZ' are repeatedly made and broken (who says China's so different from the West?).
Yet, this cure might be worse than the disease. Larger bureacracies tend to become bloated, cumbersome & inefficient. The takeover of responsibilities will initially fuel internal conflict, even if the potential for long term overhaul is worthwhile.
I wrote this back in 2021 👇
Nothing that's happened since has changed my view that economic stagnation is the most likely outcome for China, and we're only just getting started.