We found something unexpected when skimming through the website of China's finance ministry.
While most China pundits keep close track of China's monthly loan creation and, especially these days, its Total Social Financing number to get a sense of what, if any, credit is being created outside of conventional lending channels within China's shadow banking system, one just as critical please to keep track of Chinese credit is the monthly report on national state-owned and state holding enterprises.
Such as this one from October 22 [8], which reports that as of September 30, total liabilities of state-owned enterprises had risen to 77.7 trillion yuan. Why is this notable? Because the monthly update just preceding it, reported a total debt [9]figure of "only" 71.8 trillion yuan: a whopping increase of almost CNY 6 trillion, or USD $1 trillion, in just one month.
This is the biggest monthly increase by a massive margin among China's SOE by orders of magnitude, and yet just to get a sense of the magnitude of debt held at China's SOEs, even this record monthly increase is not even 10% of the total debt held by China's state-owned enterprises which stood at CNY78 trillion or USD $12 trillion at the end of September, more than the total Chinese GDP.
[10]
What can explain this snap? There has been very little commentary on this particular surge aside from a report posted on Wall Street.cn [11], and translated by Chiecon [12], which reports the following:
China’s state owned enterprises added almost 6 trillion yuan (around 1 trillion dollars) of debt in September, described by Luo Yunfeng, an analyst at Essence Securities, as “an unprecedented increase in leverage”. This means that not only is the government abandoning its deleverage policy, it is actually increasing leverage.
According to Luo “it’s possible that debt that was originally classified as government debt, has been reallocated as SOE debt”.
This might be a reflection of how the government plans to tackle its massive debt. Luo mentions that one of the obstacles to managing government debt is that it remains difficult to draw a line between government and SOE debt. The crux of of current reform plans to increase the role of market forces is aimed at resolving this issue.
If it really is the case of shifting government debt to SOEs, then it represents a step forward for this reform, and the prospect of revaluing credit risk. Another implication, it seems unlikely there will be a pause in government debt increase over the fourth quarter.
This raises the more important question of what will be the impact of this enormous debt? Over the past few years credit expansion has surpassed economic growth, and with the governments aggressive leverage, will this lead to a greater waste of resources?
Ironically, "shifting" the debt - no matter how troubling - would be by far the more palatable explanation. Because if somehow China had quietly "created" $1 trillion in debt out of thin air parked subsequently on SOE balance sheets, that would suggest that things in China are orders of magnitude worse than anyone can possibly imagine.
Still, if China did not create this debt now, it will eventually:
This raises the more important question of what will be the impact of this enormous debt? Over the past few years credit expansion has surpassed economic growth, and with the governments aggressive leverage, will this lead to a greater waste of resources?
[W]ith China experiencing slowing economic growth, and no turnaround on the horizon, its seems likely the Chinese government will continue to increase leverage. In September, China Merchants Securities stated that since Chinese government debt leverage ratio is still low, lower than the US, Europe and Japan, there is still more room for leverage.
It's low? Really? Because according to the following McKinsey chart total Chinese debt was $28.2 trillion as of Q2 2014 (it has since risen well over $30 trillion), and represents nearly 300% debt/GDP.
[13]
But there is another implication. If China's is indeed merely stuffing government debt on SOE balance sheets as the report suggests...
Haitong Securities said at the start of the year that in order to prevent systemic risk the focus over the next few years will be on government leverage. Based on the experience of other countries, monetary easing almost certainly follows an increase in government leverage, with interest rates in the long term trending to zero.
... then China, while ultimately having to engage in QE, will last out the current regime as long as possible, offloading government debt in ever greater amounts to SOE until finally their debt capacity is maxed out.
Then, and only then, will China unleash the world's last remaining debt monetization episode, whereby the PBOC will proceed to openly monetize the roughly $3-4 trillion in total debt China creates every year. At that point the "Minsky Moment" of not only China [14], but the entire world, will have arrived.
[15]
