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04/11
Aggressive Government Investment Increases Concerns over Bad Loans, Poor Efficiency
With the approach of the important Central Meeting for Economic Affairs, criticism of the current stimulus policy is becoming louder. The early December meeting will determine China’s monetary policy, foreign exchange policy, and fiscal policy for 2010.
China’s economic slowdown began at the end of 2007. Many banks’ non-performing loan (NPL) totals have expanded since the fourth quarter of 2008, mainly from export-related textile and light industrial companies as well as real-estate firms with tight cash flow. Firms in cyclical industries borrowed aggressively when the economy was red-hot but were hit hard when the economy slid. NPLs first appeared at city commercial banks that were disadvantaged in bidding for government sponsored stimulus projects and their clients were mainly small and medium-sized enterprises.
The China Bank Regulatory Commission (CBRC), worried that an economic slowdown was bound to cause the deterioration of banks’ earning capacity and asset quality, quickly responded to control the rebound of NPLs. But the government bailout program and oceanic lending of 2009 made the banking industry watchdog nervous. In 2008-Q4 and 2009-Q1, the CBRC twice ordered commercial banks to increase their provisions rate to 130% to cushion the possible shock of NPL increase. CBRC officials have also closely monitored the banking system’s asset quality.
The conflict between banking regulation and economic stimulus has become intense recently and the watchdog is barking louder. The credit surge and 4 trillion yuan stimulus package have served to camouflage the deterioration of banking asset quality. The quick loosening of credit made it easier for firms to borrow at interest rates lower than their prior outstanding loans, and borrowing from Peter to pay Paul now prevails, especially for poorly performing companies.
Risk is accumulating. Poorly managed companies are taking advantage of the loose credit policy to increase company leverage, exposing the banks to greater and greater default risk.
Investment projects from the stimulus package, where loans have largely been directed, are largely dominated by local governments, the magnitude of whose debt is opaque. According to a State Council-affiliated think tank, the contingent debt of local government may total 1 trillion yuan. Loans to local government could become risky assets if local government finances do not rebound in 2010.
It is becoming clear that the banks’ future is at the mercy of the effect of economic stimulus. If China’s exports continue to decline and the stimulus effect fades, China’s banking system, having survived the global financial crunch, could become the victim of bad loans amassed from the stimulus package. China has to pray for a stable recovery in 2010.
While, increasingly, government officials are becoming concerned over the unsustainability of China’s investment-driven growth, the Industry and Ministry of Industry and Information Technology (MIIT), whose interests differ from the National Development and Reform Commission, the all-powerful ministry carrying out the intervention, sees China’s economic growth in 2010 as still relying on investment growth.
A problem is that the investment growth is extremely inefficient. Since 2003, the ratio of capital formation to GDP has been over 40%. In 2008 it was 43.5%, twice the world average. Between 2004 and 2008, China’s ratio of fixed capital investment to the increase of GDP, input used to produce one unit of output, averaged 5.61, peaking in 2008 at 7.58. For the first three quarters in 2009, the real growth of fixed capital investment increased by 37.4%, showing growth more driven by investment.
And consumption is contributing less to growth. In 2008, the ratio of consumption to GDP was 48.6%, 13.7 percentage points lower than in 2000. In particular, the consumer consumption ratio declined to 35.3%. Both ratios are far below the world average.
Worse yet, the investment growth is driven mainly by government, with the private sector watching and waiting. Without private sector participation, any consumption growth will be a short term effect.