China’s economy, a vital driver of global expansion, grew 6.9 per cent last year, the slowest in a quarter of a century. Beijing is seeking to retool China’s economy away from the investment- and export-led growth of the past to one more driven by consumer demand. It is also trying to reform lumbering, loss-making state-owned enterprises to make the sector more efficient.
But the transition is proving bumpy, raising fears of a hard landing, and global markets have been alarmed by slowing expansion.
The government has been loosening monetary policies since late 2014 and more recently has been stepping up investment, but growth in the first three months of the year still slid to 6.7 per cent.
This week the Communist Party of China’s official mouthpiece People’s Daily in an article said the nation must turn off the taps of credit-driven growth to avoid a financial system crisis in the face of rising bad loans and other risks. It cited an “authoritative source” saying China’s economic trend will be “L-shaped”, rather than “U-shaped”, and definitely not “V-shaped”, but the government will not use excessive investment or rapid credit expansion to stimulate growth.
Here is what is ailing the Chinese economy:
Much of China’s huge debt overhang from the global financial crisis was generated by Local government financing vehicles (LGFVs) which – in addition to funding legitimate infrastructure – became infamous for building ghost cities and roads-to-nowhere as local officials took advantage of crisis level ultra-low borrowing rates.
This helped push China’s debt-to-GDP ratio to more than 240 percent at the end of 2015, estimates from the Bank for International Settlements show.
For example, China’s state-owned rail corporation is more than $600 billion in debt, reports said, almost twice the size of Greece’s obligations.
The China Railway Corporation (CRC) operates the country’s trains, including an already world-beating 19,000-kilometre (11,800-mile) high-speed rail network, with at least another 11,000 kilometres planned.
But according to a recently released financial report, it owed 4.14 trillion yuan ($614 billion) at the end of April, said respected financial portal Caixin.
In comparison, Greece, whose debt crisis has threatened the eurozone and needed repeated bailouts, had an estimated public debt of 311 billion euros ($356 billion) at the end of last year, according to the European Union’s Eurostat.
China Railway Materials is one of the influential firms to have reported debt problems amid increasing debt defaults in the country this year that have rattled its markets.
FLIGHT TO SAFETY
Despite the concerns flagged by analysts, LGFV bonds are proving relatively attractive to investors as a rising number of corporate defaults – including by some non-LGFV state firms with weaker backing – undermines confidence in company debt.
Defaults have been on the rise this year, including in industries, such as steel, that suffer from over capacity.
“Managers are increasingly concerned about corporate bond credit quality and so they’re getting back into government or quasi-government debt,” said a director at a foreign buy-side money manager in Shanghai.
Yields on three-year AA-rated LGFV bonds, which in mid-2015 were higher than regular enterprise bonds, now trade 30 basis points cheaper. Enterprise debt is a category of the market mainly used by state affiliated borrowers.
“It’s easier to raise money right now, after all LGFV bonds are basically half government bonds,” says Li Xiangdong at the Qinhuangdao Development Investment Holding Group Co Ltd, an LGFV owned by the coal port city of Qinhuangdao in China’s struggling Northeast. “Default risks are low.”
There remains a significant inventory of unsold houses in some of the smaller, more provincial tier 3 and 4 Chinese cities that developers will focus first on selling before constructing new properties, said Standard & Poor’s analyst May Zhong.
In the smaller cities, with less well-disciplined developers and weaker demand, inventories of unsold housing have not fallen enough.
“Until we see meaningful destocking in the tier 3 and 4 cities, then we can’t expect construction activity to pick up,” said Zhong.
China’s Cabinet approved measures to boost exports in a move that might worsen tensions with trading partners that say Beijing is flooding their markets with unfairly low-priced steel and other goods.
This comes as Beijing struggles to reduce a glut of goods in an array of industries and reverse an export decline that threatens to cause politically dangerous job losses. Its efforts so far have prompted complaints by European and U.S. steelmakers and others that it is violating its free-trading pledges.
In its latest measures, the Cabinet promised more bank lending, an increase in tax rebates and support for export credit.
Chinese exports contracted by 1.8 percent last month compared with the same period last year and are down 7.6 percent so far this year.
CORPORATE BOND CRUNCH
China’s 715 billion yuan ($110 billion) cash injection into its financial system last month has helped avert a rout in the domestic corporate bond market, easing pressure on the central bank to take more aggressive action.
The spread between China’s interbank market high-yield bond index and the AAA rated index has fallen 9 basis points since early May, after spiking nearly 20 basis points in the second half of April to its widest since 2012. Corporate yields have dropped sharply, with the interbank medium-term note index down 15 basis points since late April and other yield indices also broadly down.
Analysts attribute the fall in yields in part to the People’s Bank of China’s (PBOC) heavy late April use of its medium-term lending facility (MLF) – used to provide banks with low-cost three and six month loans.
Corporate debt yields – up by over 50 basis points in April in many cases – peaked on April 26 and 27 immediately after the central bank’s 267 billion yuan MLF injection on April 25. The injection brought the total for April to 715 billion yuan according to central bank calculations, compared with nothing in March and just 163 billion yuan in February.
The sharp bond sell-off in April had increased the risk of a further run-up in defaults and could have forced the central bank into much more aggressive action to avert a sharp credit crunch.
More than 100 firms canceled at least $15 billion of debt issuance in April following high profile defaults by state-owned firms like Dongbei Special Steel Group Co Ltd.
China is undertaking a restructuring of oil subsidies policy, according to a circular jointly issued by the State Council, Ministry of Finance, and three other ministries, the official Xinhua News Agency reported.
The oil subsidies adjustment, launched at the beginning of 2015, is aimed at promoting market-oriented behavior and will make changes to the practice of linking oil subsidies to the volume of fuel consumption, said Xinhua.
Fuel subsidies to the urban public transport, rural passenger transport, taxi, fishery, and forestry sectors totaled 504 billion yuan from 2006 to 2014, Xinhua said.
However, as the size of the subsidies grew, their effectiveness lessened, leading to the need for reform, the report said.
CAPITAL FLOWING OUT OF COMMODITIES MARKETS
The aggressive measures taken by commodity exchanges in Dalian, Shanghai and Zhengzhou to rein in speculation, from increasing trading fees and margins to widening daily movement limits, have helped encourage investors to look at other markets to put their money in.
“I am taking a break from commodities futures,” said 42-year-old Ji Xiaoxu from China’s Henan province, who has been investing in futures markets since 2009.
“I am doing some U.S. stocks at the moment as there is no leverage and is safer.”
The Zhengzhou Commodity Exchange said it would effectively raise trading fees for some institutional investors for rapeseed meal futures contracts from May 13 after a recent jump in prices.
NON-PERFORMING LOANS HIT 11-YEAR HIGH
Troubled lending at China’s commercial banks reached 4.6 trillion yuan ($706 billion) at end-March, a jump of 428 billion yuan from December, official data showed, as the pace at which loans are souring has risen amid the country’s slowdown.
Chinese commercial bank non-performing loans (NPLs) rose to an 11-year-high of 1.4 trillion yuan, or 1.75 percent of total bank lending, the China Banking Regulatory Commission (CBRC) said in a quarterly report published on its website.
For Chinese lenders, the build-up of bad debts, which have increased for 18 consecutive quarters, followed the state-driven credit boom of 2009 and has shown no sign of slowing. This is making policymakers mull unconventional measures to prevent a potential debt crisis.
Many bank analysts believe the NPL situation in China’s banking sector is far more severe than official data suggests, as some banks adopt untimely loan recognition and turn to off-balance sheet lending to hide bad debts.
In a report this month, CLSA said NPLs may account for 15 percent to 19 percent of loans.