As doomed as Detroit?

China Life is also feeling liquidity crunch from policy ‘surrenders’

Living in Shenmu has long been considered a symbol of affluence. Home to a mere 420,000 people, the county in Shaanxi reputedly boasts more than 2,000 renminbi billionaires. Rich in coal, it has even been known as “China’s Kuwait” (a confusion of commodity wealth, admittedly) making it an outlier in what is otherwise one of the country’s poorest provinces.

Regular WiC readers may recall that Shenmu captured national headlines in 2009 when it was said to be pioneering universal healthcare (see WiC19; and for how other municipalities rely on overpriced drugs to subsidise hospitals, read WiC203). Such news fuelled a popular saying that having a Shenmu hukou (a household registration permit) is even better than getting one for the capital, Beijing.

But Shenmu’s reputation has experienced a major setback, with the model county suddenly drawing comparisons with the American city of Detroit. Signs of financial panic there may also point to the wider credit crunch afflicting other cities in China.

On July 15, rumours spread on weibo that the Shenmu government was about to go bankrupt and its famed social welfare schemes were be scrapped. This led more than 1,000 people to gather outside the county government’s headquarters to demand that Shenmu’s Party chief, Lei Zhengxi, not be transferred elsewhere.

It wasn’t because Lei is loved locally. Rather, there were rumours that he would soon be promoted from his current role and protesters wanted him to sort out a credit crunch before leaving Shenmu. His critics are furious, accusing him of leaving behind a fiscal deficit of Rmb60 billion ($9.8 billion).

The Global Times then reported that Shenmu authorities arrested four people for “spreading rumours”, suggesting that many of the demonstrators weren’t motivated just by the risk to their local healthcare system. Instead those present were private lenders in Shenmu, where a shadow banking system has been thriving. Typically, funds provided by coalmining barons have been used to finance government projects or to invest in riskier assets. (For more on this underground lending system, see Wenzhou’s case as reported in WiC63.) For a time all was more than well: since 2007 Shenmu has enjoyed consecutive years of 30% GDP growth. But the boom came to an abrupt halt last year when coal prices crumbled.

Local legal disputes that relate to private lending agencies have surged to more than 4,781 cases over the last year, according to Xinhua. But the biggest bust-up may centre on Zhang Xiaochang, a local tycoon nicknamed the ‘God of Wealth’. Zhang now looks more like the ‘God of Defaults’ with up to Rmb10.1 billion ($1.64 billion) of his own loans having gone bad, reports Beijing News.

Before his arrest for illegal lending in February, Zhang kept six luxury cars parked ostentatiously outside his home. Leggy Russian models were hired for the ribbon-cutting ceremony when Zhang opened a new shop selling gold. These shows of wealth helped Zhang stay atop the food chain of Shenmu’s underground lending business, syndicating funds from smaller creditors and financing larger entities such as developers and local government borrowers. The Beijing News has reported that “the big banks and high-rollers” also supported Zhang during his prime, as well as thousands of retail investors who entrusted him with their own savings. His downfall has exposed a lot of people to losses: his creditors include 1,380 private lenders, more than 20,000 individuals, 56 companies and several government officials. His debts are said to include Rmb800 million of illicit loans from China’s biggest bank, ICBC and he also borrowed Rmb120 million from Gong Aiai (the Shenmu banker reported in WiC182 as under arrest for purchasing more than 41 properties with a faked hukou).

Shenmu’s coal mines helped the county “to become rich overnight”, the Guangzhou Daily believes. But overreliance on a single industry – just like Detroit and cars – has proven its undoing. The high stakes world of shadow banking has only added to the sense of crisis. “Shenmu was too obsessed with leveraging its growth via private lending,” the newspaper writes. “Putting all its eggs in one basket has now deprived the county of financial flexibility.”

The China Business Journal agrees, using a similar analogy to highlight the county’s distress. Shenmu may face “consequences worse than Detroit’s”: a grim assessment by any standards.

Shenmu’s underground lenders aren’t the only ones trying to fend off a liquidity crisis. Developments elsewhere in China are pointing in the same direction: the sudden meltdown in China’s interbank markets in June, which saw the overnight lending rate spiking to 30% (see WiC199) appears to have been a curtain-raiser for a credit crunch across the country.

One barometer for the broader trend is the rapidly waning popularity of wealth management products (WMPs), a major conduit in the shadow banking system. Banks, insurers and trust firms have all been selling WMPs to retail investors on the promise of higher returns than those from savings accounts. The proceeds are then used to finance riskier investments ranging from loans to cash-strapped businesses to funding infrastructure and real estate projects. But according to the 21CN Business Herald, WMPs issued by trust firms in the first week of July plunged over 70% month-on-month in cash terms, as the higher yields on offer could no longer solicit interest from wary investors. The average guaranteed return of WMPs ticked up to 8.87% last month from 8.4% in June, but to little avail and 30 new WMP issuances out of 56 have failed to meet their fundraising targets.

This presents a bigger risk for trust firms than the banks, the 21CN suspects, since most new issuances were being used to refinance the redemption calls of existing WMP holders (to understand the role of trust firms in China, see issue 177).

But insurers are feeling the pinch too. China Life’s ‘surrenders’ – or cash repayments to policyholders who opt out before maturity – more than doubled to Rmb20 billion in the first quarter. The insurer said that these are mainly WMP products sold through bancassurance channels. Citing actuarial projections, the Economic Observer said China Life may face up to Rmb100 billion of redemption calls in 2013, with the China Insurance Regulatory Commission reporting that insurers’ redemptions totalled Rmb103 billion in the first five months of the year. That requires a lot of cash on hand – little wonder that a China Life insider told the Economic Observer that 2013 was going to prove a very tough year indeed.

Do the insurers have a solution? The current strategy – which might hint at desperation – is to sell more WMPs but at shorter maturities (supposedly less risky for investors) and on more attractive terms. Official data shows that insurers sold Rmb115 billion in bancassurance policies in the second quarter, up 60% from the same period in 2012 (a figure that requires context: the leap came in the period before plunging sales of WMPs started being reported by other vendors).

But perhaps the most telling sign of the liquidity crunch is provided by the country’s housing provident fund. As of 2011, less than a quarter of these mandatory savings were being drawn as housing loans (technically, eligible applicants can source mortgage finance from the provident fund) while the rest sat as zombie deposits on the books of state lenders. In what can only be described as peculiar, many of these accounts now appear to be overdrawn too. According to the Economic Information Daily, many local governments are proving unable to meet homebuyer demands when they seek to withdraw their savings from the provident fund. Many of them are being asked instead to go for loans from the state banks, with local authorities promising to subsidise the higher interest payments by means of compensation. The suspicion? That local governments have raided their housing funds to finance their budgets but cannot raise the cash to replenish them.

At least the state newspapers are on hand to offer words of comfort. The cash crunch is just the “labour pain” of China’s economic restructuring, the People’s Daily suggested, terming it “necessary medicine” to squeeze out industrial overcapacity. But there was no need to worry about a wholesale financial meltdown, the editorial assured.

Let’s hope so.

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