07 Jun. 2013 | Comments (0)
As we have been reporting since early this year, China's credit intensity has been increasing at a worrying rate for some time now. Credit intensity refers to the ratio of new credit to incremental GDP growth in an economy. As this report from Bloomberg News shows, the declining effectiveness of new credit expansion is beginning to worry both mainstream observers and China's leaders, especially given China's reliance on lending to stimulate growth.
Stories like these reinforce our position that the old model has run its course, and that China has little choice now but to rein in its Total Social Financing and accept much lower growth rates, or risk a calamitous financial crisis and hard landing.
China Failure to Grow With $1 Trillion Is Warning to Li: Economy
The government’s broadest measure of credit rose 58 percent to a record 6.16 trillion yuan ($1 trillion) in January-to-March, when gross domestic product gained 7.7 percent, compared with 8.1 percent a year earlier. Each $1 in credit firepower added the equivalent of 17 cents in GDP, down from 29 cents last year and 83 cents in 2007, when global money markets began to freeze, according to data compiled by Bloomberg.
The diminishing returns to lending heighten focus on the need for what the International Monetary Fund said yesterday are “decisive” policy changes in the world’s second-largest economy. Without a refocus away from state-approved projects, Li and President Xi Jinping risk overseeing both a further slowdown in growth and an increase in non-performing loans.
“Less efficient and more highly leveraged borrowers have been kept afloat, tying up credit that could be used to generate more growth,” said David Loevinger, former senior coordinator forChina affairs at the U.S. Treasury Department. “To boost growth, China needs to channel more financing to its private enterprises, which are both more profitable and less leveraged than their state-owned counterparts.”
State enterprises have seen their return on equity fall to 5.9 percent last year from 10.2 percent in 2010, according to the Ministry of Finance. The biggest concern from China’s credit surge is the money going to companies and state-run enterprises whose performance is deteriorating, Francis Cheung, head of China-Hong Kong strategy at CLSA Asia-Pacific Markets, wrote in a May 9 report.
Signals from China’s bond market, which has expanded 39 percent so far this year compared with the same period in 2012, indicate businesses are struggling to improve profitability even with greater access to credit.
Borrowing in the debt market by the biggest Chinese companies is more than five times a measure of their operating earnings, twice the leverage ratio in 2007, according to data compiled by Bloomberg. State-owned enterprises in energy and power production are among the biggest borrowers, including China National Petroleum Corp., the nation’s largest oil producer, and China State Grid Corp., the country’s largest power distributor.
Among 102 non-financial companies in the MSCI China Index (MXCN), total debt over earnings before interest, taxes, depreciation and amortization rose to 5.74 times based on the latest filings through May 28, from 2.49 times in 2007.
One example of what Loevinger, now an emerging-marketsanalyst in Los Angeles at TCW Group Inc., called “inefficient and leveraged borrowers,” may beLDK Solar Co. (LDK), a maker of solar panels. The company, which cut solar-cell production capacity by 89 percent last year, said in April it’s in the process of getting a new loan facility of about 2 billion yuan.
With debt of $3.1 billion, seven straight quarterly losses and cash at a three-year low, LDK needs access to funds “to get through this very challenging time,” Chief Financial Officer Jack Lai said on an April 18 conference call. The announcement came after larger competitor Suntech Power Holdings Co. (STP)’s biggest unit was forced into bankruptcy in March.
The 2014 yuan bonds of LDK, which failed to fully repay $23.8 million of convertible notes in April, slid to a seven-month low of 34 yuan per 100 yuan face value earlier this month.
Since taking office in March, Li has pledged to reduce government interference and boost the role of private companies. He said March 17 that cutting the government’s power amounted to a “self-imposed revolution” and earlier this month signaled in a speech broadcast to government officials around the nation that he would prefer relying on “market mechanisms” for growth rather than stimulus or direct government investment.
China’s leaders are already experimenting with some changes, including to the household-registration system that hampers urbanization. Other reforms, such as to land rights and income distribution, may be decided later this year at a Communist Party forum.
Xi and Li have signaled they’re willing to tolerate slower growth if it’s more sustainable in the longer run and provides a better quality of life for the nation’s 1.35 billion people. Xi said May 24 that the environment won’t be sacrificed to ensure short-term economic expansion, as the government faces rising public discontent over pollution and food safety issues.
Li said this week that 7 percent average annual growth is needed this decade as the country seeks to double per-capita income. That’s lower than the 7.5 percent target the government set in March for this year.
Forty-one percent of respondents in a Bloomberg global poll of investors this month saw China’s average growth rate falling to 6 percent to 7 percent over the next five years, while 18 percent said it will slump to less than 6 percent. Even with an 81 percent increase in credit in April from a year earlier, manufacturing contracted in May for the first time in seven months, according to the preliminary reading of a Purchasing Managers’ Index from HSBC Holdings Plc and Markit Economics.
The benchmark Shanghai Composite Index fell 0.3 percent at the close, extending the drop to 4.8 percent since this year’s high on Feb. 6.
David Lipton, the IMF’s first deputy managing director, warned yesterday that rapid credit growth “raises questions about the quality of the investment and the impact that may have on repayment capacity” for companies and local governments. China’s leaders have assured the IMF that reining in credit expansion is a priority, Lipton told reporters in Beijing.
China had snapped seven quarters of decelerating growth in the fourth quarter only to slow again in the first three months of 2013. Europe’s debt crisis is curbing shipments abroad, manufacturing gains are weakening and a government anti-extravagance campaign has restrained restaurant and retail sales.
“Such stalling is extremely rare in recent macroeconomic cycles,” Stephen Green, head of Greater China research at Standard Chartered Plc in Hong Kong, wrote in a May 10 note. “Once China’s growth starts accelerating, it usually continues.”
Green sees the injection of credit fueling an uptick in output toward the end of this quarter and next, when he forecasts growth edging up to 7.8 percent as housing, infrastructure and exports strengthen.
Companies may be holding some of the new credit in reserve in bank deposits, according to Michael Werner, a banking analyst with Sanford C. Bernstein & Co. in Hong Kong. A 3.1 trillion yuan increase in corporate bank deposits in March may indicate companies front-loaded lending to guard against any crackdown on credit channels after Xi and Li took office, he said.
“That tells me that not all of the money has been allocated yet into the economy,” Werner said.
The diminishing impact of credit on growth shows that companies are restraining investment because they recognize that the “outlook for sustainable final demand is weak” unless new policies boost household consumption, said Ramin Toloui, the Singapore-based global co-head of emerging markets portfolio management at Pacific Investment Management Co., manager of the world’s biggest bond fund.
“China’s challenge used to be to mobilize the factors of production -- labor, capital, and technology -- to service boundless global demand,” Toloui said. “Now the challenge is to unleash the potential of Chinese households to serve as sources of that demand.”