While most "developed world" people have heard of Hong Kong and Macau, far fewer have heard of China's province of Guangdong [10], which is somewhat surprising. With over 100 million people, a GDP of nearly $1 trillion - the biggest of all Chinese provinces, this South China Sea adjacent territory is perhaps China's most important economic dynamo. One of the key cities of Guangdong is Dongguan [11], which as the map below shows is a stone's throw from Hong Kong, has a population of nearly 10 million, and has long been considered Guangdong's boomtown and one of China's richest cities.
[12]
One notable feature about Dongguan is that it is home to the New South China Mall [13], which is the world's largest. It also happens to be mostly empty ever since it opened in 2005. Which perhaps is a good segue into this story. Because while for the most part the city of Dongguan has been a story of prosperity, a wrinkle has appeared. According to the South China Morning Post, which cites researchers at Sun Yat-sen University, this city is now on the brink of bankruptcy.
Make that a big wrinkle.
The irony, of course, is that as always happens, while everyone has been expecting the muni collapse to take place in the good old US of A, it may be about to strike with a great vengeance and furious anger none other than that credit black hole, in which nobody really knows who owes what to whom, China.
How is it possible that a city which as the SCMP describes was once a backwater farm town until the late 1980s, and then as China boomed was transformed into one of the most important hi-tech manufacturing centres in the world, and about which an IBM vice-president famously said a mere 15-minute jam on the expressway there would be enough to cause worldwide fluctuations in computer prices, could be facing bankruptcy?
The answer is an absolutely fascinating story, one which for the first time exposes what could be the most sordid underbelly of the broken Chinese shadow credit system, and which demonstrates very vividly just what the hard Chinese landing will look like. It also explains precisely what the real creditor-debtor relationships are like in a country in which the banks are the equivalent of government entities, and which do little if any retail crediting in a time when the government is set on contracting the money supply at the wholesale, if not at the bank level (recall the now daily reverse repos conducted by the PBOC).
Most importantly it reveals the monetary dynamic "on the ground" - one which is vastly different than the one in the "western world."
The question is whether the story of Dongguan is an isolated one. Alas, just like there is never one cockroach, we are confident that many more such provinical centers are currently undergoing the same challenges, which if unresolved would lead to a tsunami of municipal, county and city level defaults, that would leave China in ashes.
Ironically, Meredith Whitney may have had the municipal default theme right. She was just envisioning the wrong continent...
From SMCP [14]:
Boom city Dongguan faces bankruptcy
Dongguan's derelict factories and huge deficits send chilling warning to a China in slowdown
After three decades of spectacular growth, Guangdong's boom town of Dongguan is on the brink of bankruptcy.
Up to 60 per cent of its villages are running up deficits and will soon need a bailout from the township, researchers at Sun Yat-sen University have discovered.
It is a dramatic turn of fortune for Dongguan - one of the richest cities in China - and could foreshadow a wider fiscal crisis as the country's economy cools.
Local government debt hit 10.7 trillion yuan (HK$13.16 trillion) nationwide at the end of 2010, equivalent to about 27 per cent of gross domestic product. Credit rating service Moody's estimates the actual figure could be about 14.2 trillion yuan.
Bai Jingming, a senior researcher at the Ministry of Finance, estimated in 2009 the total debt of village authorities could total 10 per cent of the country's GDP, but there is no official data.
Bai said many village chiefs he interviewed had no idea how much debt they had. Yet their failings could bring serious political and financial instability at higher level government right down to the grass roots.
Experts have found Dongguan's village debt woes stem from two factors: a tightly-bound landlord economy, plunged into crisis by failing factories in the global downturn, and political pressure on local village chiefs to pay generous "dividends" to voters under the immature rural election system.
"The financial problems of the villages are much more serious than expected," said Shao Gongjun, the owner of a printing company who blogs on Dongguan's economy. Shao attributed much of the crisis to the local authorities' dependence on rental incomes.
A backwater farm town until the late 1980s, as China boomed Dongguan was transformed into one of the most important hi-tech manufacturing centres in the world.
An IBM vice-president famously said a mere 15-minute jam on the expressway there would be enough to cause worldwide fluctuations in computer prices.
As industry thrived, the population swelled from 1.8 million in the '80s to more than eight million. Most of the peasants cashed in and built matchbox homes on their land, letting the flats to migrant workers. Village authorities leased community land to factories and collected rent as their main source of income.
This worked perfectly until the recent downturn. Shao said many factories had either closed or moved out over the past five years to inland provinces with lower costs.
The number of Hong Kong-backed factories has dropped by 15 per cent since 2007. As factories and migrant workers left Dongguan, rents nosedived.
"I'm so worried that before long I will lose my tenants and the flats would be left deserted," said a 61-year-old woman surnamed Luo. She put together two million yuan from her life savings 10 years ago and with bank loans built a six-storey apartment building in Luowucun in Zhangmutou county. Her family occupied the first floor and let the rest out to migrant workers.
Luo used to collect about 15,000 yuan a month in rent - nearly 10 times what an average worker earned. But rents have dropped by a third since 2007.
The fall in rental values forced 60 per cent of the 584 villages in Dongguan into budget deficits, the study by Professor Lin Jiang of the finance and taxation department of Lingnan College at Sun Yat-Sen University found.
Lin's estimate is based on a study of 30 villages in relatively well-off counties, such as Tangxia, Houjie and Humen, in May.
The figure may not reflect the whole picture, but it gives a good snapshot of the problems authorities face.
"They are in deficit because their incomes are shrinking while their expenses are going up," Lin said.
This is an unexpected sideeffect of China's fledgling grass-roots democracy.
While competitive elections are still absent at almost all levels of government, Beijing has started to let villages choose their leader through universal suffrage. These elections have been getting increasingly competitive, and candidates often promise to pay generous "dividends" to villagers to attract votes.
"In some rare cases, the leader-elect promised to give each household 10,000 yuan per month," Lin said. The money would come from the village community "investment" - effectively, the rent they collected from factories.
Lately, village chiefs have found it difficult to fulfil such election pledges. But instead of reneging on their promises and sparking the anger of villagers, they turn to the rural credit co-operatives - the de facto local banks - for short-term loans at interest rates as high as 30 percentage points.
Banks are willing to lend, because they know that the township government would have to bail villages out if things go wrong.
"Some village leaders are now really worried that the bank may come to call in the loans," Lin said. "If the villages default, the burden would be transferred to the county or the township government."
The Dongguan government is in poor shape to handle a crisis. Its GDP growth slowed to 2.5 per cent in the first half of the year. The average growth in the past eight years was about 11 per cent.
Xu Jianghua, Dongguan's party secretary, urged villages last month to stop raising money to pay dividends. Few took heed.
Village chiefs may argue paying dividends are not the sole cause of their debt. They also have to pay for local fire and police services - even though these are supposed to be the local government's responsibility.
For years, the township government underinvested in such services, knowing they would be taken care of by the cashed-up village authorities.
Eddy Li, president of the Hong Kong Economic and Trade Association, said in some counties police would refuse to investigate a crime unless it involved more than 20,000 yuan.
Shao estimated Zhangmutou county authorities alone have accumulated a total of 1.6 billion yuan in debt. Annual revenue is only 600 million yuan.
Shao said the Dongguan government needs structural reform to end its reliance on rental income. He proposed the township give residency to migrant workers so they can contribute more to the local economy.
"Without a radical change in the social structure, the economic transformation will never succeed," he said.
And some pictures from the city that may soon be the first cockroach observed once the light was truly shone:
A row of empty shops that have been idle for more than nine months – a common sight in what was once a hi-tech heartland. Photo: May Tse
Commercialism came storming into rustic residential areas. Photo: May Tse
Boarded up shops in the suburbs of Zhangmutou. Photo: May Tse
Many roads but few cars in the once desirable district of Zhangmutou, a favourite with expats and retirees. Photo: May Tse