Not our words but Societe Generale’s, or at least their China macro strategist Wei Yao, who believes credit risk is worse than official non-performing loan data suggests. So much worse that — while government intervention will prevent an outright crisis — a “multi-year and bumpy” landing is now expected by SocGen.
Non-performing loans are still at a fairly low level of 0.9 per cent across China, notes Wei, although about three times that amount are “special mention” loans, or those in doubt but still performing. Rates can also rise quickly, thanks in part to China’s tangled shadow banking system: in one year, Wenzhou went from the lowest rate of any Chinese city at 0.37 per cent to 2.85 per cent at the end of July.
Wei says the number of press reports about companies in default or with severe cash flow problems has surged since the beginning of the second quarter.
This is all coming amid rapid credit growth. While previous financial crises don’t show a very consistent relationship between the scale of credit growth-to-GDP and the scale of the subsequent crisis, research compiling 42 crisis episodes shows that average annual credit growth to GDP was on average 8.3 per cent preceding these events. China’s growth was 27.9 per cent in 2009 and 20 per cent in 2010…
The economic slowdown does not seem to be the only cause, and, in many cases, not even the major one. The common mistakes include involvement in speculative activities (eg. property speculation or commodity trading), massive capacity expansion (eg. shipbuilding and solar panel manufacturing), outsized commitments to complicated webs of mutual loan guarantees and high exposure to underground banking (eg. many SMEs in Zhejiang).
However Wei also attributes it to a bigger problem… one that’s related to China’s massive stimulus of 2008-09 which furthered the economy’s imbalance:
There is also a structural element in China’s NPL cycle. As we pointed out last week, many industries have massive excess capacity after years of aggressive expansion that ran way ahead of demand growth. Eventually, China has to eliminate these inefficient capacities. This process will take some time, during which faster depreciation in the form of deleveraging and consolidation will be unavoidable
It’ll probably also involve some will on the part of the authorities beyond just telling banks to roll over loans.