Bad debts in the Chinese banking system are ten times higher than
officially admitted, and rescue costs could reach a third of GDP within two
years if the authorities let the crisis fester, Fitch Ratings has warned.
The
agency said the rate of non-performing loans (NPLs) has reached between 15pc
and 21pc and is rising fast as the country delays serious reform, relying
instead on a fresh burst of credit to put off the day of reckoning.
It would
cost up to $2.1 trillion to clean up this toxic legacy even if the state acted
today, and much of this would inevitably land in the lap of the government.
“There
are already signs of stress that point to NPLs being much higher than official
estimates (1.8pc), most obviously the increased frequency with which the banks
are writing off or offloading loans,” it said.
The banks
have been shuffling losses off their balance sheets through wealth management
vehicles or by classifying them as interbank credit, seemingly with the
collusion of the regulators. Loans are past 90 days overdue are not always
deemed bad debts.
“The
longer debt grows, the greater the risk of asset quality and liquidity shocks to
the banking system,” said Fitch. Capital shortfalls are currently 11pc to 20pc
of GDP, but this threatens to hit 33pc in a worst case scenario by the end of
2018.
“Defaults in China could lead to mutual credit
guarantees in the background pulling other firms into distress. A large
increase in real defaults risks triggering a chain of bankruptcies that
magnifies the potential for financial instability,” it said.
“Mid-tier
banks have the weakest buffers, and are the most vulnerable to funding stress,”
said the report, by Jonathan Cornish and Grace Wu.
The
damage eclipses losses during the global financial crisis in Britain and
the US, where the direct costs of bank rescues were roughly 8pc of GDP.
It would be closer to the trauma suffered by Ireland, Greece, and Cyprus
when their banking systems collapsed, but on a vastly greater scale.
The
Chinese state has deep pockets but strains are mounting. Public debt has
reached 55pc of GDP following the bail-out of local governments. This is now
higher than among ‘A’ rated peers, mostly in the developing world. “Pressure on
China’s sovereign rating could emerge if general government indebtedness were
to rise significantly,” said the Fitch report.
China let
rip with a fresh burst of credit growth from the middle of last year after a
series of policy errors triggered a recession – with ‘Chinese characteristics’
- in early 2015. It ditched any serious effort to reform the economy and opted
for stimulus as usual, cutting interest rates and the reserve requirement
ratio.
Credit
reached 243pc of GDP by the end on last year, double the level in 2008. Banking
system assets have grown by $21 trillion over that time, 1.3 times greater than
the entire US commercial banking nexus.
Fitch
estimates that the ratio will jump to 253pc this year, and 261pc next
year. Curbs on property lending have been relaxed and much of the fresh credit
is going to housing speculation, driving up prices over the last year by 40pc
in Hefei, 37pc in Shenzhen, 37pc in Nanjing, and 31pc in Shanghai.
Loans
increased by $1.2 trillion in the first five months of this year alone. The
authorities have since begun to tap on the brakes, implying a fresh economic
slowdown in early to mid 2017. Pessimists fear this could prove to be an
inflection point for China and the world.
The
credit addiction is becoming increasingly dangerous for two reasons. The
efficiency of credit has collapsed. Fitch estimates that each new yuan of
credit generates just 0.3 yuan of economic growth, down from 0.8 before the
Lehman crisis.
At the
same time, the growth rate of nominal GDP has halved from around 15pc to nearer
7pc, making it much harder for the country to work off the debt load – the
so-called denominator effect. A pattern has become entrenched where credit is
rising much faster than the underlying nominal base of the economy, and is
achieving ever less in the process.
“We think
the Chinese authorities can still clear this debt,” said Mark Williams from
Capital Economics. “In an extreme scenario - with non-recoverable loans of 25pc
– we calculate that the government would have to spend a full 35pc of GDP
bailing out the banks. That would lift debt to 90pc. That is high but in
principle it is possible.”
Mr
Williams said it will be very hard for Beijing to repeat the tricks used to
overcome the last banking crisis in the late 1990s. A roaring global boom – and
surging nominal GDP – whittled down the burden of state’s bail-out bonds, and
the use of “financial repression” to hold down deposit rates for effectively
imposed the cost on savers.
Neither
are now possible. Deposit rates have been liberalized. The global context is
entirely different and China is starting to face demographic strains from a
shrinking work force. Mr Williams said the biggest worry that the Communist
Party fails to deliver on reforms, leading to economic stagnation and a
darkening calculus for the debt trajectory. “We’re afraid that growth could
drop to 2pc,” he said.
Fitch
doubts that there will be a Lehman-style meltdown or a great drama akin to
western banking crises, since the four big lenders are instruments of the
Communist Party. “The dominance of the state-owned banks and the fact that they
are funded overwhelmingly by deposits mitigate against a financial crisis,” it
said.
The
denouement is more likely to be a murky compromise, a Japanese picture of slow
deflation and muddling through. A lost decade may lie in store.
The
Telegraph
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