Monday, 15 March 2010
The threat posed to Beijing by bad debts
Former president Jiang Zemin, according to diplomatic lore, once boasted about his knowledge of finance by reciting “assets equal liabilities plus equity” to his bemused US counterpart Bill Clinton. The joke, it seems, is that this basic accounting formula should be common knowledge and so it’s absurd to show off with it. But, as people fret about China’s financial position today, it may be good to remind them of this formula to see the big picture.
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The threat posed to Beijing by bad debts
11 March 2010
Former president Jiang Zemin, according to diplomatic lore, once boasted about his knowledge of finance by reciting “assets equal liabilities plus equity” to his bemused US counterpart Bill Clinton. The joke, it seems, is that this basic accounting formula should be common knowledge and so it’s absurd to show off with it. But, as people fret about China’s financial position today, it may be good to remind them of this formula to see the big picture.
Beijing and China bulls naturally like to focus on the equity part, such as its US$2.4 trillion foreign exchange reserves. But more recently, global investors - especially those with bearish views on China - have suddenly rediscovered what has been well known for years: there are massive bad debts sloshing within the mainland financial system, and they are not properly recorded on the national balance sheet. Most of them are legacy debts accumulated during the Jiang era, and large portions came from bad loans that had to be carried off the balance sheets of the largest state-run banks before they could list on exchanges during the stock market boom years. But besides banks, a disturbing number of state-owned companies, many of them “zombies” because local officials loathe shutting them down and cutting jobs, have not made payments for years and are effectively defaulters. Their debts and sometimes all their assets are taken over by other state-owned companies and local governments in order to keep operations running and jobs afloat - all for the sake of “social harmony”.
Beijing and local authorities, naturally, like to keep quiet about these debts, the levels of which are anybody’s guess. The four asset management companies set up by the central government to manage soured loans are rarely forthcoming with the numbers. An estimate of US$911 billion in total bad loans by Ernst & Young in 2006 quickly brought Beijing’s ire and was retracted.
China has lived with massive bad debts and prospered; it surely helps that unlike most heavily indebted governments in the West, Beijing is sitting on the world’s largest reserves. So why the sudden interest in China’s bad debts? One reason is that there is money to be made in these bad assets and some adventurous western investors, hedge funds and specialists in distress debts want to buy some for themselves. But they find a highly unco-operative bureaucracy at all levels of government on the mainland, from municipal offices all the way to Beijing, and some are complaining loudly about it.
But, the more relevant reason for the world’s sudden interest has to do with its reaction to China’s astonishing recovery from the global credit crunch. From their initial astonishment, many global investors are taking off their rose-tinted glasses and, by reflex, are starting to look for bad signs ahead for China. Unrecognised bad debts are clearly not good, even if some have been around for ages.
But, what they are really concerned about is not old debts, but new ones. The mainland’s massive stimulus programme from last year has sparked fears of overinvestment, overcapacity and a property market bubble. Beijing has ordered banks to cut back on loans to state-run enterprises and, in some cases, halt new mortgage lending. But while more bad debts are a virtual certainty, whether they will reach unmanageable levels is another matter. The equity on the national balance sheet gives rise to some confidence that a financial crisis can be averted. But mounting bad debts could still spell the end of China’s growth story. That is one reason why Beijing is still fixated on high growth rates in the next few years.
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