Could the Next Credit Crisis Start in Shanghai?
The sustainability of China’s debt-fueled, investment-led growth is little questioned—it simply can’t go on forever. The real question is how it will end.
Andy Xie thinks the crunch will come in 2012 when the Fed starts tightening and the wall of money that has been betting on renminbi appreciation and Chinese growth prospects reverses course. Pivot Capital Management thinks the crash is coming this year. China is more developed than most estimates assume, and the productivity of new investment is dropping rapidly, the hedge fund argues.
Others, like The Economist, note infrastructure bottlenecks remain in China, suggesting that there is still plenty of room for investment to grow. Besides, the high savings rate (35%) and the low loans/deposits ratio at Chinese banks (67%) imply that China’s financial system can withstand quite a shock. Sure the loans/GDP ratio surged to 119% in 2009 from 97% the year before, but that’s only because it had been falling since 2003 as credit was overly tight in China, the optimists argue.
Although the financial system looks relatively stable (assuming banks have no problems raising capital this year), things could change quickly. Deposit growth kept pace with that of loans last year, suggesting many of the funds lent out were stashed in savings accounts in anticipation of tighter lending conditions in the future. If these deposits are drawn down this year as liquidity is tightened, and government-linked projects still require additional loans, the banks’ loans/deposits ratio could worsen quickly. (This is why RGE believes the government will slow the pace of new infrastructure investment in 2010, though it will require difficult coordination between the NDRC and the PBoC.)
Likewise, BreakingViews’ Wei Gu argues that there could be problems if the borrowers that drove the 43% jump in household credit last year are not the same households that keep China’s savings rate high. If this is the case, a surge in credit defaults would be possible, even without a drop in the household savings rate. Although consumer loans represent a small share of total loans outstanding (16%), they have grown rapidly in recent years. At the end of 2007, consumer loans outstanding were only RMB3.28 trillion or 13% of the total, according to two PBoC researchers. RGE estimates that this had nearly doubled to RMB6.27 by the end of 2009.
Will China face a credit crisis in the near future? As RGE has argued before, it depends on how the lending binge is reversed. If credit dries up quickly from policy tightening, non-performing loans could shoot up dramatically. But if it is slowed at a moderate pace (from 30% lending growth in 2009 to 20% in 2010, and so on until it is more or less in line with nominal GDP growth), the damage could be mostly contained. (Higher inflation would be a risk still, depending on how quickly this was done.)The larger danger for China is if credit does not start to slow. Then leverage would increase further and asset prices would soar, leaving China hugely exposed to a “Minsky moment.”
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UPDATE: The PBoC released more detailed statistics for the financial sector today, which shows that consumer loans were RMB5.53 trillion at the end of Q4 or 14% of the total. The discrepancy with the RGE estimate was due to a higher portion of the household loans going to farmers than I had assumed. Still, the debt outstanding on credit cards had shot up to RMB220 billion at the end of Q3 2009, from basically nothing in 2007.