Towards a New Crisis

As we approach the fourth anniversary of financial hurricane nearly wrecked the world economy, dark clouds are gathering once again. Europe is seized with a renewed fear of eurozone collapse, as US recovery continues to show signs of stalling, the slowdown of the Chinese economy is pushing the world towards a new crisis. A hard landing in China could expose a large number of countries to unforeseen consequences and dash hopes of global recovery. China’s plight drives the final nail into coffin of once fashionable theory of “decoupling”, which argued for autonomous economic sphere around China that could soar even as the US economy went into a tailspin. (source: Nayan Chanda – Businessworld – 06/09/2012)

In the dark days of 2008-09, following collapse of major financial institutions, China stood out as a beacon of hope, biggest engine of global growth. Buoyed by Beijing’s $586-billion economic stimulus package in November 2008, the Chinese economy bounced back and was soon growing at its customary 8% clip. The stimulated growth that cushioned the economy from impact of the falling export demand has, however, run its course. High inflation and the stimulus-fuelled real estate bubble have been aggravated by sagging global demand. Europe’s appetite for Chinese goods has fallen sharply, roiled by the deepening sovereign debt crisis. With high US unemployment and fears of recession, demand in China’s biggest market is similarly flat. If Beijing were tempted to depreciate renminbi in a bid to boost exports to the US, it could trigger an ugly row, especially in an election year. The impact is being felt all across China. Car dealerships are bursting with unsold automobiles, warehouses are groaning under mountains of unsold goods, and millions of apartments remain vacant. In a bid to liquidate inventories, companies are engaging in vicious price-cutting wars. Latest data show that export orders are falling at their fastest pace since 2008 crisis. Cutbacks in import orders by Chinese firms are now spreading gloom to three continents. Germany, Europe’s export engine, sells much of its machine tools and equipment to China, but is seeing a fall in GDP growth. Sovereign debt crisis, which has hit European banks, has indirectly affected China’s exports to poorer countries. The emerging economies of Africa and Latin America rely heavily on European banks for trade financing, but lenders have stopped issuing letters of credit. China’s export engine consumed about 20% of world’s non-renewable energy, 23% of major agricultural crops, 40% of base metals. Chinese slowdown has hurt Australia, Brazil and African countries, which have been feeding China’s export engine with raw materials like metals, agricultural commodities and petro-chemicals.

As one official of a major Brazilian iron ore company put it, with Chinese slowdown “golden years” are gone. Australia’s BHP Billiton has abandoned plans to build world’s biggest open pit copper and uranium mine and hopes of creating thousands of jobs have been dashed. The fall-off in orders for Chinese consumer goods also transmits pain to South Korea, Taiwan and a host of other countries engaged in manufacturing supply chain. Japan’s export of heavy machinery has, for example, slumped, leading, in turn, to a drop in country’s imports of commodities. Given the extent to which global demand has contracted, China’s main avenue to avoid a hard landing is by engaging in a domestic decoupling of sorts, by moving away from export-driven investment to consumption driven growth. In the past 5 years, China has introduced pension and health insurance in a bid to encourage a greater domestic consumption. Worried about medical burden and old age, the Chinese have traditionally saved more than they consume. However, persistently high private saving rates suggest limited success in changing economic gears. As China struggles to rebalance its economy and its manufacturing sector stalls, resulting lower global commodity prices could provide a silver lining to developing countries not endowed with these resources. Weak demand from China could also lower the price of oil and divert some FDI flow away from China. Thanks to strong FDI inflow, China, with its $3.2-trillion reserve, is better prepared to face storm; but its falling current account surplus has shown its fortune is not decoupled from the rest of the world. 


Acerca de ignaciocovelo
Consultor Internacional

One Response to Towards a New Crisis

  1. Financial collapses may have different immediate triggers, but they all originate from the same cause: an explosion of credit. This iron law of financial calamity should make us very worried about the consequences of easy credit in China in recent years. From the beginning of 2009 to the end of June this year, Chinese banks have issued roughly 35 trillion yuan ($5.4 trillion) in new loans, equal to 73 percent of China’s GDP in 2011. About two-thirds of these loans were made in 2009 and 2010, as part of Beijing’s stimulus package. Unlike deficit-financed stimulus packages in the West, China’s colossal stimulus package of 2009 was funded mainly by bank credit (at least 60 percent, to be exact), not government borrowing (…..)

    But the potential risk for a financial tsunami is greatest in China’s shadow banking system.

    Because of very low-yield for savings by Chinese banks (since deposit rates are regulated) and competition among banks for deposits and new fee-generating businesses, a complex, unregulated shadow banking system has emerged and grown significantly in China in the last few years. Typically, the shadow banking system pushes something called “wealth management products,” which are short-term financial products yielding a much higher rate than bank deposits for investors. To evade regulatory oversight, these products do not appear on a bank’s balance sheet. According to Charlene Chu, a highly respected banking analyst for Fitch ratings, China had about 10.4 trillion yuan in wealth management products, about 11.5 percent of the total bank deposits, at the end of June this year. Since borrowers that use funds provided by wealth management products tend to be private entrepreneurs and real estate developers denied access to the official banking system, they have to promise a higher rate of return. Obviously, higher return also means higher risks. Although it is impossible to estimate the percentage of non-performing loans extended through wealth management products, using a conservative 10 percent baseline would mean another 1 trillion yuan in potential bank losses. The shadow banking system has another function: channeling funds to borrowers or activities explicitly banned by government regulation. In the last two years, the Chinese State Council has tried to deflate the real estate bubble by limiting bank loans to real estate developers. But banks can skirt such restrictions by ostensibly lending to each other, with the funds ultimately going to financially stretched real estate developers. Chinese banks do this out of their own survival instinct. If they do not lend to effectively delinquent real estate developers who have borrowed large amounts, they would have to declare these loans non-performing and suffer losses. On the balance sheets of Chinese banks, such loans are technically classified as claims on other financial institutions. According to a recent report in the Wall Street Journal, inter-bank loans today account for 43 percent of total outstanding loans, 70 percent higher than at the end of 2009. Disturbingly, none of these huge risks are reflected in the financial statements of Chinese banks.

    The largest state-owned banks have all recently reported solid earnings, high capital ratios, and negligible non-performing loans. For the banking sector as a whole, non-performing loans amount to only 1 percent of total outstanding credit. One things is evident here. Either we should not believe our “lying eyes” or Chinese banks are trying to hide the mother of all debt bombs.


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