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"Critical" Debt "Domino Chain" Threatens To Destabilize China's Financial System, SocGen Says
Since the beginning of March when we first explained why QE (or at least some manner of “unconventional” monetary policy) may be inevitable in China, we’ve tracked developments around the country’s local government debt refi effort closely. For those in need of a refresher, we've documented the program from inception to implementation and beyond in exhaustive detail in the following posts:
- China's Latest Spinning Plate: 10 Trillion In Local Government Debt
- China Floats QE Trial Balloon, PBoC May Launch LTROs
- Failed Chinese Local Bond Offering Leads To PBOC Easing Confusion
- China Officially Launches Critical Local Government Debt Swap — But Is The PBoC Really Just Issuing Treasury Bonds?
- China Creates Perpetual Leverage Machine After Dropping Debt Directive
- Confusion Reigns At PBoC As Multi-Trillion Yuan Bailout Threatens To Undermine Rate Cuts
While we won't endeavor to recap the entire series of events here, note that the entire effort comes down to one simple thing: China's local governments have managed to accumulated a debt pile worth 35% of GDP via off-balance sheet, high-cost loans which are now being swapped for low interest muni bonds in an effort to reduce debt servicing costs and extend WAM. This is part of a wider effort on China's part to deleverage an economy laboring under $28 trillion in debt. This deleveraging effort goes far beyond local government debt, as Beijing is now moving to allow for more corporate defaults as the country moves to liberalize its financial markets.
There's a critical link between local governments' off-balance sheet financing (the loans that China is now working to restructure) and China's financial system as a whole. The LGFVs (the vehicles local governments used to skirt official borrowing limits) are guaranteed by provincial governments, as are some critical state owned enterprises. In turn, LGVFs and SOEs have guaranteed the debt of private enterprises. This state of affairs, combined with the central government's willingness to allow for more defaults, sets up the potential for a destabilizing knock-on effect that could trigger the beginning of a long-delayed NPL cycle at Chinese banks and send tremors through the system. SocGen has more:
As the growth deceleration intensifies and financial market liberalisation accelerates, denying the debt problem is becoming an increasingly unviable strategy. The Chinese government may be able to keep papering over the debt problem by continuing to offer implicit credit guarantees to everyone for another year or two. However, developments in the past year suggest that top policymakers are now willing to face up to the problem and work on a deleveraging plan. One recent announcement in this direction came from Premier Li, who told a roomful of international and domestic media in March this year that allowing credit events to occur and leaving them to the market to work out will be necessary to address the moral hazard problem.
Market pricing of interest rates is at the core of interest rate liberalisation, which policymakers are keen to push through. That is simply impossible without the existence of risk. Besides installing a deposit insurance scheme, which implicitly admits the possibility of bank restructuring, onshore bond defaults have started to emerge alongside the acceleration of interest rate liberalisation. By the time of this publication, we have counted four credit events in the onshore secondary bond market, including one SOE, and close to a dozen private placement bond defaults (Table 1). While in a few default cases (e.g. Chaori and Zhongsen) investors were eventually paid, the occurrence of these credit events have kick- started risk revaluation in the bond market (Chart 7). We think that, due to its signalling effects, the bond market will continue to be a cautious test ground for the government.
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The fiscal reform will also bring more credit risk to the fore. The fiscal reform has started to limit local governments’ ability to extend credit guarantees at a time of slowing domestic growth and tightening global liquidity. Local governments have played a critical role along the credit risk chain. They extend credit guarantees to LGFVs, local SOEs and even some private companies that are deemed local champions, and it is also a common practice for LGFVs and local SOEs to provide credit guarantees to small and medium-size private enterprises. As this critical domino chain of local governments in China’s credit risk situation begins to wobble, there could be significant ramifications for broad financial market stability. Such a chain reaction seems to have begun: SOEs and LGFVs are the guarantors in a majority of private placement bond default cases but have failed to provide credit protection as promised (Table 1).
Apart from reform, the pressure exerted by the multi-year growth deceleration is already weighing on commercial banks, whose NPLs have doubled since 2012 (Chart 8), indicating that private sector debt restructuring has begun and that the process so far is rightly being left to market mechanisms. Consequently, for the first time Chinese loan officers are prioritising containing credit risk over growing loan books, and this has gotten in the way of the transmission of monetary policy easing.
For reference, here's what SocGen had to say after reviewing several LGFV bond covenants:
- Leverage of LGFVs is generally high, with the average D/E ratio close to 200% and the median at around 150%.
- Profitability is very low, with ROA at only 2%. Nearly 80% of LGFVs in the sample have negative cash flows. Since LGFVs are mostly operating in the infrastructure space, the lack of short-term return is partially understandable.
- Debt-servicing capacity is simply dismal. The effective interest rate of these LGFVs is already very low, at less than 2.5%, probably implying a big share of non-interest bearing debt (e.g. accounts payable). Even so, half of the LGFVs still have an interest rate coverage ratio of less than one, which generally points to a situation of financial stress. The corresponding debt-at-risk accounts for close to 60% of total debt in the sample.
Admittedly, all of this is terribly convoluted, and indeed, that's precisely the point. China has gone to great lengths to mask its enormous debt problem by spreading credit risk across a dizzying variety of financing vehicles that are carried off-balance sheet and, in the case of China's banking sector, outside of traditional loans. Now, Beijing is attempting to untangle the mess. The only question is whether it's possible to delverage the system before it collapses under the weight of its own complexity.
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lol
I get a kick out of how some think that China is going to wipe the floor with the US in the upcoming monetary shift. They have the same debt based monetary system we do with nearly as much debt. Just because their private sector is more indebted, compared to our public sector makes them no less vulnerable to a debt collapse.
Perhaps, but does China have $1+ quadrillion in derivatives waiting to crush their banking sector?
They have three.
proof ?
I just started 6 weeks ago and I've gotten 2 check for a total of $2,200...this is the best decision I made in a long time! "Thank you for giving me this extraordinary opportunity to make extra money from home. This extra cash has changed my life in so many ways, thank you!" www.earnmore9.com
Gordian knot, knot that gave its name to a proverbial term for a problem solvable only by bold action. . According to tradition, this knot was to be untied only by the future conqueror of Asia.
"Gordian knot, knot that gave its name to a proverbial term for a problem solvable only by bold action. . According to tradition, this knot was to be untied only by the future conqueror of Asia. "
It is purported that Alexander The Great 'untied' the Gordian Knot by hacking it to shreds with a sword...
It's these type of non sequiturs that will insure you will remain nothing more than a male prostitute.
Okay China,
Reprice gold, silver, platinum, palladium and let's get on with this..
Don't you understand yet, as much as a virtue is time and patience, that the west will turn you into a opium addict, and try destroy with card shark games first?
China s gold could be worth the world, or as I see, a radioactive smoldering pile of nothing.
We will see...
it's not Gutenberg but the Chinese who invented printing press. it's not Rothschilds but the Chinese who invented paper money. it's not Morgans but the Chinese who invented financial derivatives. drop your American-centric worldview the sooner, the better. How many really understand China?
They also invented gunpowder. But it took the west to put it proper use- warfare.
Back in the 1970s there was a division of Xerox known as PARC (Palo Alto Research Center). You may think very little about Xerox today other than copiers, but back then they were the Apple of their generation. Please don't laugh, I'm mean this very seriously. They really were. PARC invented some really cool shit. Touch screen displays, the Graphical User Interface and the Mouse. They even invented and sold their own line of computers.
They did ALMOST NOTHING with any of those inventions. Do you know why? They couldn't figure out how to use any of them to help sell more copiers. Again, please don't laugh, because I am dead serious. They were so focused on their near-monopoly in the copier business (and all the wonderful per-page click charges those devices generated to fill their corporate coffers) they never used most of the wonderful stuff PARC invented for them.
Bill Gates may have started Microsoft with a cheap command-line operating system he bought from IBM (called DOS), but he knew a good thing when he saw it, so he stole the idea of a Graphical User Interface from PARC that we now know as Windows. Steve Jobs obviously saw the same potential, just sooner than Gates and, well..... you get the point.
you don't really have to regurgitate those logically irrelevant stories spoon-fed to you here.
here's the for dummies version to those who desire oversimplified answers. now ask yourself the following questions:
1. how is root money created in the usa? and how's that done in China? any difference?
2. how's national/local debt gov debt created in joosa? and in China? interest goes to whom? any difference?
By now you have better understanding of China through your own little mental exercise.
China artificially peggs their currency to the dollar.
Why not develop your own personality, instead of always trying to be like us?
nope smart ass they dont do that they artifically lowers the yuan value against dollar just to make their exports attractive .
... but the Chinese who invented...
Living in the past won't help you.
Tell me what the Chinese have invented in the last hundred years and you must exclude all the technology that was delivered to them on a silver platter by the USA & EU after Nixon "opened china".
Seriously. Please educate this grasshopper. What has China invented from 1850 to 1975?
A simple thank you would have sufficed.
And for the record, that is not a story I regurgitated after reading it on ZH. I worked for Xerox. Who have you ever worked for? But thank you so much for your great words of wisdom on money creaton that every ZH reader has already known for years, kid.
It's not that I don't understand China.
It's just that I don't give a flying fuck.
Cheers.
I understand but it is dusk in Murika and one way or the other you are fucked.
As a chinaman, shouldn't you be sweating your stock positions this weekend instead of spewing your usual "China is the next superpower" bullshit?
Your China story is over. China wasn't smart enough and capable enough. China is still mostly uneducated peasants, and you're the proof.
Now, I hear your daddy calling you back to the fields, nongmin.
shouldn't you be sweating too peasent ? You're also a Chinaman
"Consequently, for the first time Chinese loan officers are prioritising containing credit risk over growing loan books, and this has gotten in the way of the transmission of monetary policy easing."
That is damn funny. There's either money to give out or there isn't. They stopped containing credit risk ... hmmmm, probably when Lloyd Fuk Yu Blankfien got a finger up their ass.
[apologies for FUTA reference]
Debt is not a problem in the Peoples Republic of China! The fucking Keynesian commies tell us all the time that the debt is owed to ourselves over here, so the sky's the limit!
Its like ten fiddy or some shit anyways for a billion plus people, practically sofa cushion coinage that dropped out of your pajamas while watching Real Lives of the Szechuan's or sumpin. Mortgage your chopsticks or your damned pig if you have to.
Go for it! ;-)
A Wisdom Q&A between a Chinese Master and his young Apprentice
Apprentice: Master, what is the statutory price of 1 ounce of gold?
Master: $42 my young apprentice.
Apprentice: So why is it quoted at the LMBA price?
Master: So the meat puppets can be slaughtered.
Apprentice: So how do I avoid being one of the meat puppets?
Master: Don't volunteer for your own servitude and let the westerners think they are masters.
That story ends with the Master telling the Apprentice to buy gold at $1900 in 2011, you know. The master was a literal retard.
Chinese mastered the art of buy high, sell low.
In the case of all commodities from 2009-2013, it was the $28 trillion flood of new money from Chinese banks that drove up prices on iron ore, copper, and even gold. The people who say China is buying cheap commodities now overlook the fact that Chinese money printing of over $15 trillion in new bank assets, i.e. reckless loans, was the reason commodities were ever at that height.
CHAU, CHAD, ASHR
I've always been critical of the Domino chain. Their pizza is awful.
They have been trying really hard to re-engineer their recipes.
Can someone please explain to me why the U.S. debt ceiling has been frozen for almost 4 months?
This must be why> CONgress busted the cap early and are using "extreme measures". (reserve funds to finance the ponzi)
Total Federal Government Debt in 2015. At the end of FY 2015 the gross US federal government debt is estimated to be $18.628 trillion, according to the FY16 Federal Budget.
I thought the deficite was shrinking?
</sarc>
Yen Cross,
a trillion here, a trillion there, pretty soon you are talking about some real money.
At this point why freeze anything though, you are correct.
So banks are gonna print more money?
I'm shocked! Shocked I tell you!
Sounds like they could add America to this article...
well technically they could slaughter a lot of Chinamen and redo all their per capita data..
also no lender, no debtor win win for somebody...