|China’s corporate crisis|
|Wednesday, 12 October 2016 04:54|
Not clear how the debt-equity swaps will fix this
With corporate China alone sitting on debt of $18 trillion – that’s 160% of GDP, up from around 100% just 7-8 years ago – and this threatening to wreak havoc on the already over-leveraged financial system, the government has just released guidelines on converting the debt owed to banks into equity capital which is to be owned by the banks. Given the extent of how badly impaired corporate China is – over 15% of the loans given by banks are to companies whose earnings are less than interest repayments – the debt-equity swap is only meant for firms who are not beyond repair and whose loans are worth salvaging; the government has already said it will not be responsible for the losses incurred during the process of conversion in case the firms don’t turn around. The extremely stressed loans – where earnings are not enough to cover even interest costs – given by banks, according to the IMF, add up to around $1.3 trillion and this is to be compared with the $2 trillion of tier-1 capital and reserves that banks have. The problem gets more complicated when you look at the spillover possibilities since smaller banks are much more vulnerable and there are also non-bank financial institutions that are over-leveraged. Not surprising, then, that S&P has just put out a report banks may need as much as $1.7 trillion in recapitalization by 2020.
Theoretically, the Chinese budget could help bridge part of the recapitalization gap since, at 1.8% of GDP, there is room to increase the deficit and spend more. But once you add what are called local-government-financing-vehicles – that’s how the government gets more spending into the economy – the actual deficit is more in the 8-9% range. While there could still be a case for allowing the deficit to rise to solve a long-term problem, this will leave much less money for spending in areas like infrastructure – that, in turn, will further lower China’s growth, and worsen the financial position of an already-stressed China Inc. All of this, of course, assumes there is no banking crisis – as the Bank for International Settlements (BIS) pointed out a few months ago, two thirds of all banking crises were preceded by a massive run-up of credit – China’s credit-to-GDP is roughly 30% higher than the long-term trend. What makes matters trickier is the fact that, to the extent the debt is foreign, forex outflows also need to be watched carefully. While a China-led global crisis cannot be ruled out, the days of China contributing meaningfully to global growth seem to be over for now.