China’s stealth de-leveraging

That faint, hissing sound you hear is the air coming out of China’s debt bubble. Western analysts remain obsessed with the size of China’s debt problem, for example, this Bloomberg News story this morning:

(Bloomberg) — China has a $28 trillion problem. That’s the country’s total government, corporate and household debt load as of mid-2014, according to McKinsey & Co. It’s equal to 282 percent of the country’s total annual economic output.

President Xi Jinping’s government aims to wind down that burden to more manageable levels by recapitalizing banks, overhauling local finances and removing implicit guarantees for corporate borrowing that once helped struggling companies. Those like Baoding Tianwei Group Co., a power-equipment maker that Tuesday became China’s first state-owned enterprise to default on domestic debt.

Now hold that thought, and consider this: China’s also trying to prop up a $10.4 trillion economy that’s decelerating and probably will continue to do so through 2016, or so says the International Monetary Fund. The economy expanded 7 percent — the leadership’s growth target for this year — in the first quarter, the weakest since 2009 and a far cry from the 10 percent average China managed from 1980 through 2012. Against this backdrop, a barrage of recent policy moves out of China in recent days comes into sharper focus. It also helps explain why various parts of the government don’t always seem to be working from the same playbook.

What the beancounters forget is that a big rise in debt caused  the subprime crash in the United States, by issuing trillions of dollars of subprime mortgages against little or no equity, while the big rise in debt protected China against the global recession that began in 2008. Chinese home loans have about 2 RMB in equity for every RMB in debt, according to Hong-Kong based investment bank Reorient Group.

China is gradually deleveraging, though, through the following mechanisms:

1) Equity is slowly replacing debt as the soaring stock market cheapens the cost of equity capital, including at the small-and-medium enterprise level through the Shenzhen and Qianhai stock exchange;

2) Debt is shifting out of the usurious shadow banking market (where loan rates for small businesses can reach 20%) to banks, and to securitized debt markets (Alibaba, China’s e-commerce giant, has listed an asset-backed security based on small business loans on the Shenzhen stock change;

3) The commercial banks are recapitalizing (including $110 billion of preferred debt issuance in 2014);

4) The government is starting to swap high-yield and sometimes dodgy Local Government Financing Vehicles (LGTV’s), the equivalent of US municipalities’ economic development bonds, for provincial bonds backed by tax revenues–at much lower interest rates;

5) The overall level of interest rates is coming down from the highest in world (4% real short-term yields vs. negative yields in most of the industrial world.



Categories: Asia Unhedged