As one of the world’s most successful investors, George Soros can claim to have made the right call more often than the wrong one. But even he might have been surprised to see his most recent views on China boosted so quickly by the support of a third party.
Speaking at the Boao Forum earlier this month, Soros compared the growth of China’s shadow banking sector with the US subprime mortgage market that’s usually blamed for triggering the global financial crisis in 2008.
Soros claimed that China’s leaders needed to be aware of the parallels too. “If the American experience is any guide, the authorities have a couple of years to bring shadow banking under control,” he told the conference, according to Century Weekly.
Just a day later, Fitch Ratings downgraded China’s local currency debt to A+ from AA-, the first downgrade since 1999.
Citing concerns over the rapid expansion of credit since 2009, Fitch also claimed that bank credit to private companies is now worth 135.7% of GDP, the third highest level in any of the emerging markets that it covers.
Furthermore, if loans from the shadow banking industry are included, total debt could be as much as 198% of GDP.
“The proliferation of other forms of credit beyond bank lending is a source of growing risk from a financial stability perspective,” Fitch said in a press release.
One week on, and Moody’s Investors Services has sent a similar message, cutting China’s outlook to stable from positive. Of course, that doesn’t mean that disaster is just around the corner. Moody’s Aa3 rating gives China a rating bettered only by a small group of wealthier, developed economies. But it does highlight growing concerns over how the country is tackling the murky world of shadow banking.
The fear, chronicled previously in WiC, is that much of the expansion in credit has occurred in the largely unregulated world of trust companies and social financing. Most of this debt appears off balance sheet, but China’s banks could ultimately have huge exposure to the sector.
In addition, there is a belief that a large chunk of shadow financing loans have gone to risky industries – including some borrowers in the property industry – or to local governments that have spent the proceeds on projects unlikely to generate enough cash to service the loans.
Some of the borrowing simply looks spurious. Tom Holland in the South China Morning Post gave an example of a steel company in Lanzhou which has borrowed Rmb2.5 billion ($404 million) via a trust loan for earthquake reconstruction. The odd thing about that? The US Geological Survey says that there hasn’t been a significant earthquake near Lanzhou since 1995.
Critics will say that the ratings agencies are being unnecessarily fearful, scarred by their experiences in failing to forewarn of the global financial crisis in 2008.
Another view is that China has shown itself capable of managing debt blowouts in the past. In the late nineties, Beijing responded to a bad loan crisis by establishing four asset management companies to absorb Rmb1.4 trillion of non-performing loans. Each fund was given Rmb10 billion of capital and a decade to get rid of the bad debt. The plan largely worked. One of the four, China Cinda Asset Management, is even planning to raise $3 billion in a Hong Kong listing, although sceptics say the listing process will throw more light on how bailouts of this type really work. “They’ll need to tell investors how much profit they have each year, where it comes from and what their long-term strategy is,” an analyst told Bloomberg.
If more debt does start to go bad, perhaps the asset management companies will be asked to repeat the trick they performed in the nineties. Lai Xiaomin, president of Huarong Asset Management, told a meeting in Beijing that local government debt is a major problem and that growing levels of bad loans in the banking system could prove to be another new opportunity for his firm, Bloomberg reports.
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