A new crisis is brewing in China, where debts at leading corporates and banks have risen to unsustainable levels, threatening domestic and global economic stability and increasingly the likelihood and regularity of future shocks.
At the heart of the problem sits the toxic brew of non-performing loans (NPLs) within China’s 4,000-plus central, state, and city-level banks, some of the country’s leading private sector economists have told Emerging Markets.
According to government data, the banking industry’s NPL ratio was 1.75% at the end of June 2016. But independent voices say this drastically underestimates the problem. “The real rate is far higher than the official data suggests,” says Xiang Songzuo, chief economist at Agricultural Bank of China. “China’s commercial banks readjust and redefine what counts as a bad loan at will. The real NPL ratio is between 7%-8%.”
Francis Cheung, chief China strategist at Hong Kong-based investment bank CLSA, believes the true ratio of bad loans to all lending in the country is even higher, “around 15%”, or 10 times higher than official estimates,” he says.
CLSA’s Cheung reckons that a quarter of all firms listed in mainland China do not make enough profit to pay their interest expenses.
China has attempted to tackle the issue. Earlier this year, it re-opened its securitized bad debt market. In September, the government kick-started a debt-to-equity swap reform with Beijing-based Sinosteel paving the way, swapping Rmb27bn ($4bn) of its debt for equity convertible bonds.
But this redistributes corporate debt rather than solving the problem, and could undermine the wider banking sector. Société Générale has warned that large-scale SOE debt restructuring could plunge the country’s banks into crisis.
GOING UNDER
Experts say the government will ultimately be forced to let some SOEs, and even a few non-systemic banks, fail.
“The state will be forced to let some companies go under, and the banks will just to absorb the losses, says Ag Bank’s Xiang. “The biggest eight steel firms have total outstanding loans of Rmb3tr, and 30% of those loans will go bad in the next year or two. The coal sector is even worse off. When they fail — and they will — it’s probably that more than a few smaller local banks will go under as well.”
China’s cautious policymakers are presented with a dilemma. They can either act to dissolve its most troubled SOEs, thus raising the prospects of a Lehman-like banking crisis, or to continue to roll over debt, thus increasing the chances of China suffering a long, Japan-like stagnation.
Either way, a reckoning is coming. “High debts raise the chances of China seeing a serious shock, at least once a year,” says CLSA’s Cheung.” It was the domestic A-share crisis last year; next year, he tips prices in the property sector, which have surged in recent quarters, to crater, “dampening consumer sentiment, and causing a surge in bank NPLs. Debt levels are making China’s economy fragile.”