Fingers crossed the defaults don’t spiral out of control
Shanxi Zhenfu Energy, Shanghai Chaori Solar Energy, Zhejiang Xingrun Real Estate, Haixin Steel, Highsee Iron and Steel … barely a week seems to go by without news of one or another Chinese entity in trouble, either unable to repay its loans or simply going bust. Not surprising, then, that Premier Li Keqiang talked of some defaults being unavoidable, though he underlined that the government would take steps to ensure they didn’t deteriorate into contagion. Shanxi, a coal miner, was unable to repay the $496 million it took from China Credit whose bonds, in turn, were sold by the Industrial and Commercial Bank of China (ICBC); Chaori failed to make payment on the interest of $163 million of bonds it had raised; Xingrun has $566 million of debt that it cannot repay; Highsee owes $482 million ...
Given China’s National Audit Office put total debt, of the central and local government, at 53.5% of GDP in 2012, the outlook doesn’t look frightening. The debt is lower than that for comparable countries, and the Chinese government has huge surpluses and forex reserves, technically making it possible for the government to bail out troubled entities—when markets across Asia collapsed on news of Shanxi’s default, behind the scenes discussions resulted in ICBC assuring bond holders it would not shirk its responsibilities. It also helps that other levers—interest rates, exchange rates and bank lending—largely remain under the control of the Chinese government. Soothing as that sounds, there are several problems with the argument that the defaults and bankruptcies are part of an organised blood-letting by the government, to slowly get the market to start pricing debt right. For one, there is no telling how accurate the numbers are, or the extent to which there could be contagion. The Financial Times (FT), for instance, reports steel traders in China fearing Haixin is deeply entangled in debts with coal suppliers and other local firms—in other words, were Haixin to go under, there would be a wave of defaults across the region. Two, though the debt numbers for local government—30.6% of 2012 GDP—look reasonable, these are up 67% since 2010, suggesting attempts to control local government debt have been largely unsuccessful. Also, a large part of this debt has been invested in property markets. A BNP Paribas analysis points out that real estate investments are up to 15% of GDP, up from 10% in 2008; and that the market value of floor space under construction is up from 65% of GDP in the 5 years to 2008, to around 155% of GDP today—in other words, there is a huge property overhang on debt. Add China Inc’s dues to this, and FT reports total debt has nearly doubled from 125% of GDP in 2008 to 215% in 2012.
Given how China has defied sceptics for over three decades now, it is tempting to assume a gradual letting-out- of-air will take place instead of a disorderly default scenario. Ruchir Sharma, who heads emerging markets for Morgan Stanley, however, points out that of the 33 countries which had extreme credit booms, 22 suffered a credit crisis in the next 5 years; not one got away without either a crisis or a major economic slowdown—this includes the likes of Japan, Taiwan and Korea who had many of the safeguards mentioned in the context of China, such as large forex reserves. Fingers crossed is a good posture to adopt.