Bad Loans Could Pose Threat To Chinese Economy

Today we have a couple of new reports on the economic situation out of China, which I’ve been attempting to keep tabs on in this space for several months.  To briefly recap, property values in China have exploded over the last couple of years, and many fear that the situation there is becoming economically untenable.

First, from yesterday’s New York Times, David Barboza reports that there are increasing fears about off-balance sheet loans made by Chinese lenders.  The Chinese Banking Regulatory Commission warned banks to discontinue this practice and ensure there are enough reserves to cover an increase in defaulted loans.  You may recall that a few weeks ago Chinese regulators ordered banks to conduct stress tests to determine the effect a 40 percent decrease in property values might have.  Those kind of price declines could cause widespread problems for the Chinese and the global economy as a whole.

A couple of weeks ago the ratings agency Fitch cautioned that these types of loans were causing Chinese bank liabilities to be underestimated.  According to the article, Fitch estimated there may be as much as $350 billion worth of unrecorded Chinese loans.

A key quote from the article:

“They’re stuck in a policy bind,” says Michael Pettis, a professor of finance at Peking University in Beijing, noting China’s heavy dependence on investment-driven growth. “They have to choose between cleaning things up and maintaining high growth.”  Pushing in the opposite direction are banks and investment trusts, which want to continue pumping money into the economy to bolster their profits. Analysts say the banks and trusts have been adept at evading the rules with clever and complex financial products.

Next up comes a report from PropertyWire.com that says a Chinese real estate association is petitioning the government to cease tightening measures intended to cool off the superheated Chinese housing market.  Zhu Zhongyi, vice president of the China Real Estate Association said the tightening measures should be eased in order to stabilize the market.  While property values in China are still increasing, the pace at which they increased has slowed.

Chinese bank lending almost doubled in 2009 as lending guidelines were loosened.  The Chinese authorities must walk a fine line here, as too much of a slowdown could cause Chinese property values to crater, which could potentially cause unrest and or financial devastation amongst the masses of people who have leveraged themselves in order to purchase homes at increasingly inflated prices (sound familiar?).

Finally, we have a story from Bloomberg that discusses some of the broader risks that the Chinese economy faces.  The Chinese economy is very dependent upon two things, cheap labor and exports, and both of those activities are at some risk.  Chinese workers are increasingly demanding higher wages and better working conditions.  Additionally, bad economic conditions in Japan, the United States, and Europe have put a damper on demand for Chinese exports.

A key quote from the article:

“The key is that weaker global growth will undermine exports, said Jackson at Royal Bank of Canada”.  If Beijing attempt to offest that with a renewed surge in investment spending it will exacerbate overcapacity and risk overheating”.

One thing that I will say for the Chinese authorities is that they seem to be cognizant they may be walking down the same path that caused many Western economies to melt down over the last three years.  Whether or not they can effectively manage the problem is another story.