A Nomura research report suggests that China’s local government financing vehicles now pose a major risk for the economy. Their debt stock has surged close to 40% of GDP over the past three years. Profitability is poor, liquidity risks are high, and solvency hinges on government support.
A Nomura research report looks at the rising financial risk premium across Asia. It shows that economic fundamentals are not as bad as they were in 1996. However, Asia’s external surplus has been eroded by a torrid financial expansion, which was fueled by very easy monetary policy. In the absence of a correction of this policy stance, there is an increasing danger that capital outflows will trigger a sudden stop to these accommodative financial conditions.
A very short note by the IMF in the run-up of China’s latest Article IV consultations suggests that the country’s fiscal position is much weaker than official statistics suggest. The augmented fiscal deficit of the country, including local government off-budget funding, is estimated to have climbed to around 10% of GDP.
Morgan Stanley’s Viktor Hjort, Nishant Sood, and Gaurav Singhal show that financial leverage of China’s corporates has reached record highs, particularly for state-owned enterprises (SOEs). Increased debt financing reflects easy credit conditions and has partly served to cover funding gaps. In case of an economic downturn, consequences for credit quality would probably be more severe now than back in 2009.
According to Nomura’s Zhiwei Zhang and Wendy Chen, “China is displaying the same three symptoms that Japan, the US and parts of Europe all showed before suffering financial crises: a rapid build-up of leverage, elevated property prices and a decline in potential growth…the most vulnerable areas are local government financing vehicles, property developers, trust companies and credit guarantee companies.”
Credit Suisse’s Dong Tao and Weishen Deng nicely summarize causes, size, and systemic risks arising from China’s rapidly growing shadown banking sector. Low regulated bank interest rates and rationed supply of credit have created ample incentives to by-pass the regular banking channels. By end-2012 the shadow banking sector has soared to about 44% of GDP and continues expanding at a torrid pace. Meanwhile, poor transparency and lack of risk management and regulation bode ill for credit and liquidity risks, and even a state bailout could involve a drastic deterioration of credit conditions.
The ECB’s new “due diligence” paper on China reiterates why severe imbalances are inherent in the country’s high-growth model. Without a fundamental overhaul the key imbalances, such as overinvestment, large state control, and financial repression are likely to persist. For now, supply side conditions suggest that this model may still deliver sufficient (8% or higher) GDP growth. Yet as trend growth will inevitably slow, severe tail risks such as “widespread corporate defaults, systemic banking sector stress and social unrest” are looming.
Chinese wealth management Products (WMPs) are a form of asset backed shadow banking deposit, paying above the rates of regulated banks. The WMPs have been soaring to become the second biggest segment of the financial system. The incur large maturity mismatches and hence are subject to serious liquidity risks.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
