In last month’s post, we highlighted real estate and slow growth warning signs of what seems to be an inevitable economic crash in China. The scariest part about these flashing signs is that there are plenty more indicators we hadn’t touched on. Let’s look deeper into some of the unemployment and debt issues China faces as it moves towards a tipping point of what could be an economic crisis.
- Fewer workers moving to cities: The workforce contracted in 2012 and 2013 by 3.45 million and 2.27 million workers, respectively. The Japanese bank, Nomura, states that the number of migrant workers has halved from 12.5 million to 6.3 million over the past four years.
- Debt, debt and more debt: Total bank debt has grown from $14 trillion in 2008 to $25 trillion today. This represents the equivalent of adding the entire US banking system in the past 6 years. A recent S&P report in June announced that China now has the largest corporate debt market in the world (although there are some questions regarding the validity of data). Furthermore, the Bank for International Settlements, has indicated in its recent annual report that China’s financial system is “flashing red” as private sector debt to GDP is 23% higher than its long run norm.
- Nonperforming loans: At the end of 2013, the 10 largest lender’s reported a 21% increase in overdue loans (a loan is overdue before it may become nonperforming) from the prior year – the highest level since 2009. Additionally, overdue loans were 31% greater than nonperforming loans – the biggest gap in 5 years. As of the end of the first quarter, nonperforming loans in China’s banks have increased for 10 straight quarters. The first quarter saw the largest increase in nonperforming loans since 2005. The concern is that reporting data is manipulated (i.e. reporting loans as overdue as opposed to nonperforming) as bank employee’s performance and pay is tied to these metrics.
- China is more connected to global banking than ever before: The exposure of Hong Kong to the property boom has been parabolic. Fitch ratings calculated Hong Kong’s exposure to China has reached $798 billion. This had grown from practically zero in 2009 to now representing more than 150% of Hong Kong’s GDP. Additionally, banks in the region, primarily in Australia, Japan, Macau, Taiwan and Singapore, have more than $400 billion of exposure to mainland China.
- Distressed investors circling the waters: Distressed funds are set to raise $2 billion, three times the amount of 2013, to invest in troubled and distressed assets in China and Asia. China experienced it first bond default (Shanghai Chaori Solar Energy Science and Technology Co.) in March followed closely by its second in the same month (Zhejiang Xingrun Real Estate Co.). The last distressed investing cycle occurred during the Asian financial crisis in the late nineties and bypassed China.
When China’s President Xi Jinping came to power he promised to promote growth while also cutting credit that is fueling a dangerous property bubble. After trying to cut credit in 2013, he has now reversed course in an attempt to increase growth.
He has his work cut out for him – it is a difficult balancing act and there is no certainty that China can navigate the current course – there is no precedent in China. He is facing massive headwinds: more debt, less growth, a property bubble, an aging workforce, higher labor costs and a fragile, opaque banking system that is more connected to the global economy than ever before.
Much of what is happening echoes the last global financial crisis. Whether it’s lax lending standards and rotten banks (US) or a state too reliant on property taxes to keep itself funded (Ireland), we have seen this picture before and it does not end well. The real question for Mr. Jinping is whether he has learned from what he has seen and heard in the West. Sometimes we have to live through it to really understand. – PJ Grzywacz