Banking & Finance

Problems in Pudong

Can China’s debt-fuelled growth model defy economic gravity forever?

A clerk counts 100 Chinese yuan banknotes at a branch of China Merchants Bank in Hefei

Banking stocks have surged

In October 2016 the International Monetary Fund warned that China was heading for a banking crisis. Its working paper urged Beijing to act quickly to rein in credit growth before the problem became systemic.

The IMF’s warnings sounded credible enough: China’s debt-to-GDP ratio stood at 169% and the IMF predicted that it would rise above 300% by 2020. But the alarm bells from Washington have had limited impact: many equity investors seem willing to bet that time is still on the Chinese regulators’ side and remain bullish on financial stocks.

Take ICBC, the biggest state bank by market value. Since the beginning of 2018, the lender’s share price has climbed more than 20%. At one point last week, Chinese media noted ICBC was worth more than Rmb2.6 billion ($410 billion). This ranked the Chinese lender as the world’s most valuable bank.

The broader rally in Chinese banking stocks has also propelled Hong Kong shares to a record high (see WiC394). “The revaluation in banking stocks has become an underlying trend,” reported China’s Economic Observer newspaper on Monday.

The optimism has been buoyed by some upbeat earnings reports. China Merchants Bank kicked off the state banks’ reporting season last week by posting a 13% rise in net profit to Rmb70 billion.

There’s also good news from industrial sectors that have long been plagued by overcapacity and soured loans. Chinalco, for instance, is likely to shrug off its dubious honour of being “the worst lossmaking SOE” this year after saying last month it expects its 2017 profits to rise 10 times. Meanwhile, Chongqing Iron and Steel said this week it expects to return to profit in 2017 after two years of consecutive losses (as a result it has been removed from a list Chinese regulators hold that threatens persistent lossmakers with delisting).

Of course, China’s financial system can be notoriously hard to fathom. Just when the data looks good, a scandal can come to the fore. And such was the case last week when the China Banking Regulatory Commission stunned the market by slapping a Rmb462 million fine on Shanghai Pudong Development Bank (SPDB) for “illegally covering up bad loans”.

In its statement, the CBRC said SPDB’s Chengdu branch had issued Rmb77.5 billion worth of credit lines to nearly 1,500 “empty shell companies” in order to cover up its bad debts to a number of property and coalmining firms.

The crackdown is part of the CBRC’s continued attempts to stamp out lenders’ dodgy lending practices. Last year, the regulator imposed fines on 1,877 institutions that are worth Rmb2.9 billion, with Guangdong Development Bank receiving the biggest penalty of Rmb722 million for fabricating loan guarantee documents.

Such revelations explain why some analysts continue to question the health of China’s banking system even after economic growth last year beat expectations. The country’s GDP grew 6.9% in 2017, beating the State Council’s own forecast as well as that of the IMF (both at 6.5%).

In another working paper published earlier this month, with the title “Credit Booms – Is China Different?” the IMF opined some “China-specific factors” such as high savings and small external debts might have set the country apart.

Yet the IMF maintains that China’s credit-fuelled growth won’t defy economic logic forever. “Historical precedents of ‘safe’ credit booms of such magnitude and speed are few and far from comforting,” the IMF cautioned. “Credit deterioration in recent years suggest its leverage expansion is increasingly unsustainable.”

Even Lou Jiwei, China’s former finance minister, shares a similar concern about the country’s financial system. “Comparing with the US financial market 10 years ago [before the 2008 meltdown]… China is messier,” Lou told a financial forum in Beijing over the weekend.

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