Rating a rare Chinese credit warning

While the debt risk may have been overstated by Fitch, China does need to address the unhealthy link between shadow lending and municipal debt.

FT.com

Yet the report that accompanies Fitch’s decision to lower Beijing’s rating from AA- to A is right to emphasise China’s rapid expansion of credit as a real threat to economic stability. There are two areas of immediate concern. First, the size of the debt mountain accumulated by local authorities. Second, the stability of China's growing shadow banking sector.

China’s municipalities have been saddled with loans since 2009, when Beijing encouraged its provinces to go on an investment binge as part of a heroic stimulus package. Roughly a quarter of these projects generated no revenue. The debt stock for local governments, unconsolidated in the public debt figures, is more than 10 trillion renminbi ($1.6 trillion), a fifth of national income. Much of it is in short-term bank debt, placed in special-purpose investment vehicles designed to circumvent a ban on borrowing.

So far, Beijing has dealt with this problem by demanding that state-owned banks roll over these debts. But this is only a palliative. The government’s push for municipalities to issue their own bonds is more promising, as it will encourage greater thrift and transparency. Yet, ultimately, Beijing will have to decide whether it intends to bail out its provinces, which would add to its own debt stock.

Just as worrying is the rise of China’s shadow banking, which is financing almost half of all new credit. True, the development of shadow banks is natural as a financial system becomes more sophisticated. Yet the products sold outside China’s formal lending sector are often murky. Too frequently, they are used to finance uncreditworthy projects, particularly in the property industry. The authorities are seeking to regulate the sector by demanding greater disclosure. Critics fear these steps will prove insufficient.

Beijing faces a dilemma: regulating fast-expanding credit flows is bound to constrain growth. But the alternative is much uglier. As the western experience of the past decade shows, economic development is real only when it is financially sustainable. Getting a grip on credit expansion should be a priority for China’s leadership.

Copyright The Financial Times Limited 2013

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles