The second bailout of Greece has been in the lime light for the past couple of weeks. While Fitch rating’s Andrew Colquhoun said today that Australian and Korean Banks are the most exposed in Asia to the European debt crisis thanks to our dependence on offshore borrowing, is there another crisis brewing around the corner with bigger implications for Australia?
While Eurozone members are bailing out Greece, its believed the China central government has been bailing out its Local Government Financing Vehicles (LGFV) to the tune of 2-3 trillion yuan.
During the last decade, the Western world, fuelled by easy and abundant credit was spending beyond their means. Household consumption was surging along, and China was in the front seat to capitalise on the moment. However, like many other economies, things turned sour in 2008 with the onset of the Global Financial Crisis (GFC). Exports practically dried up overnight for the manufacturing superpower.
To counter the effects of the GFC, Beijing embarked on a massive 4 trillion yuan economic stimulus program. In addition, local governments were told to spend and they did this via local government created companies known as SOEs (State owned enterprises) or LGFV (Local Government Finance Vehicles). They invested in infrastructure and real estate projects such as empty apartments and office towers built to keep GDP ticking along. The heightened activity of SOEs in the real estate markets along with reduced lending standards helped fuel a massive investment bubble and credit boom in 2009 and 2010. According to the Royal Bank of Scotland (RBS), “Chinese banks grew their loans by 65% since the beginning of 2009 as credit expansion was the centrepiece of China’s stimulus package during the global financial crisis. Much of these loans were channelled to LGFVs as well as the property sector.”
SOEs were bidding up prices to record levels, with Beijing’s residential land price record broken by SOEs twice within 6 hours on the 15th March last year. This caused the banning of 78 SOEs from any further real estate investments by the Assets Supervision and Administration Commission a couple days later. The commission believed 94 of the 127 SOEs had been investing in residential real estate, when real estate wasn’t even their primary business.
By June 2010, there were growing concern about who was funding this spending spree. In the post, China’s chief auditor warns of mounting debt on the 26th June 2010, we reported on Liu Jiayi, head of the National Audit Office who wrote in an annual audit report “The scale is large, and the burden is quite heavy” when referring to SOE debts. According to China’s banking regulator at the time, outstanding loans to local government financing vehicles soared 70 percent in 2009, hitting 7.38 trillion yuan at the end of that year. As infrastructure projects continue to burn cash with little return on investment, Mr Shih suggests China could be in for a “pretty large-scale financial crisis around 2012″ if nothing is done to address the issue.
But, with little ROI and a cooling property market, Beijing has been forced to inject 2-3 trillion yuan into the LGFVs. David Cui of Bank of America-Merrill Lynch Global Research indicates that “LGFV loans are at 10 trillion yuan by the government’s estimate; the ones with no cashflow support”, suggesting a second bailout may not be too far away.
Societe Generale has just released a 50 page report titled “Chinese construction bubble – Preparing for a potential burst.” Using a variety of data (cement consumption, elevators, skyscrapers, roads, railroads etc), it sets about determining if the construction bubble is myth or reality. It believes Chinese construction is ahead of the development curve in a number of areas, but while there is early signs of weakness it can’t find any immediate trigger for a downturn.
According to the report, 60 percent of new elevators manufactured in the world are fitted to buildings in China. The number installed has grown substantially from 10,000 in 1990 to more than 300,000 in 2010, representing a compound growth rate of 20% that “looks unsustainable in the mid-term”. Consumption of cement by China in 2010 exceeded 1,800 million tonnes, accounting for 55% of world demand. Average consumption per head is 1,400kg, four and a half times about the average ex-China consumption of 300kg.
Societe Generale then turns to figures on the delivery of excavators, loaders and bulldozers from the China Construction Machinery Association (CCMA). While demand has been strong up to March, deliveries are starting to fall. Excavators sales are down 65% for the month of May and down 12% over the year. It also reports “In addition, the sales volume of loaders and bulldozers also saw sharp drops May, with that of loaders falling 45% from March, the largest drop since 2001.” It believes a reason for the decline could be from financing constraints.
Fitch’s Senior Director of Financial Institutions, Charlene Chu, told Bloomberg today “We are pretty concerned about a big problem with bad debt over the next few years associated with local governments, property and all of the excesses that have been built up since the stimulus of 2008”.
“If we have a downturn in the Chinese property market it would have a significant impact on the banking sector,”
» Exclusive: China to clean up billions worth of local debt – 31st May, 2011.
» Fitch Says China Property Downturn Would Significantly Impact Banks – 23rd June, 2011.
» Banning SOE Real Estate Investment to Impact the Soaring Price of Housing: An Analysis – The Epoch Times, 23rd March 2010.
» 5 Things You Need To Realize About China’s Gigantic Bailout Of Local Governments – Business Insider, 2nd June 2011.
» Fitch flags credit-risk worry at China banks – Market Watch, 22nd June 2011.