Voices have been raised from many quarters, including these columns, over the last two years about the potential for bad debts in China to arise from the wall of money thrown into infrastructure investments at the urging of the Beijing government. From late 2008 onwards the authorities urged state banks to fund infrastructure projects as a form of fiscal stimulus. The banks responded magnificently throwing some 7.7 trillion yuan ($1.1 trillion) into the market according to Bloomberg, financing local government infrastructure projects. The Chinese regulator estimates as much as 23% of these debts may not be re-paid. This estimate implies $261 billion of debt may go sour, almost five times the level the nation’s five largest banks are currently raising to replenish capital, and four times the stock of non performing loans on the books at the end of June.
On the books is a key phrase here. Much of this bank lending has been to Local Government Investment Vehicles (LGIVs), quasi-independent entities set up because local governments cannot borrow themselves. A significant number of these 4000 companies are not generating enough, or any, revenue to pay back the interest, let alone the loans, and banks have been directed to wipe them off the books by the year-end. Many of Beijing’s banking directives over the last few months should be seen in the light of this crisis. According to the FT, last December the China Banking Regulatory Commission made it more difficult for banks to bundle their LGIV loans into securitizations banks were hiding the scale of the problem by moving them off balance sheet in this way. In March, the Ministry of Finance moved to nullify all guarantees local governments provided for loans taken by their financing vehicles, recognizing that in some cases, the guarantees were the only creditworthy assets the LGIVs had. Since then, the central government has stepped up bond issuance to help local governments fund the construction of highways and airports. Loans to property developers dropped by 62% from Q1 to Q2, this year.
In most cases it would seem the problem is not embezzlement or corruption, but simply poor lending controls. Many of the projects were or are being completed but are simply not generating enough revenue to service the debts. They were probably never commercially viable in the first place but in the euphoria of investment activity and with construction companies chomping at the bit to build, ill judged decisions were taken in haste. Local governments have also strived to out do each other with high speed train services, new motorways and new airports.
Concerns remain that the scale of the problem could be larger than it appears because contrary to central bank directives, banks are still shifting loans off balance sheet by repackaging them into investment products that are sold to investors Bloomberg reported.
Much as in the 1990’s following the last banking crisis in China when the non performing loan ratio of China’s banks reached 50% the government will, in one way or another, step in to bailout them out, in the meantime Chinese bank shares are probably not a good place to be!