China's debt dragon

The dragons in China's history were not just mythical animals, but natural events, not understood, but cause of devastation and fear. Is China's debt manifesting into its next dragon?

Developed and developing nations are relying on China to drive the global economy through the global financial crisis in the face of the European Union meltdown and a slowing United States economy. China's media reports of continuing record growth and aggressive domestic and global spending allay fears of even a slowdown.

Despite China’s confident media reports, increasingly reports are raising serious concerns at what appears to be reckless lending practices and massive hidden debt levels in China's local government, state owned enterprises (SOEs), finance, property, and stock market sectors.

China's Banking Regulatory Commission (CBRC) has expressed its serious concern by introducing new lending regulations and cutting out-of-control local government borrowings that could affect China's overall economy.

The implications of debt combined with rising overcapacity in key industries questions China's continuing demand through 2010 and 2011.

Local government debt

Land sales traditionally generate about 45 per cent of local government revenues that in turn, drive property development and infrastructure projects generating employment, and local industry and services revenues. Stimulus lending fuelling the property boom has pushed these revenues to 60 per cent.

Local government borrowings totalled US$1.6 trillion in 2004-2009.

In 2008-2009, stimulus lending on infrastructure alone reached US$1.025 trillion.

Local governments ignore China's Budget Law by creating special purpose vehicles (SPVs) as "independent" financial institutions to raise capital against local government land, implied guarantees or "promises" for infrastructure, essential, and non-essential spending.

Of the current 8,221 SPVs, local governments incorporated about 4,000 just to exploit stimulus-lending opportunities.

Banks

In the mid 1990's, non-performing loans and assets (NPLs) derailed the proposed public floats of China's four major banks.

The banks were Bank of China, Industrial and Commercial Bank of China, China Construction Bank and the Agricultural Bank of China. The Agricultural Bank failed to qualify for listing.