Charlene Chu, a banking analyst who made her name warning of the risks from China’s credit binge, said a bailout in the trillions of dollars is needed to tackle the bad-debt burden dragging down the nation’s economy.
Speaking eight days after a Communist Party newspaper highlighted dangers from the build-up of debt, Chu, a partner at Autonomous Research, said she was yet to be convinced the government is serious about deleveraging and eliminating industry overcapacity.
She also argued that lenders’ off-balance-sheet portfolios of wealth-management products are the biggest immediate threat to the nation’s financial system, with similarities to Western bank exposures in 2008 that helped to trigger a global meltdown.
The former Fitch Ratings analyst uses a top-down approach to calculating China’s bad-debt levels as the credit to gross domestic product ratio worsens, requiring more credit to generate each unit of GDP.
While Chu is on the bearish side of the debate about the outlook for China, she’s not alone. In a report on Monday, Societe Generale SA analysts said that Chinese banks may ultimately face 8 trillion yuan ($1.2 trillion) in losses and a bailout from the government, citing the scale of soured credit within state-owned enterprises.
Interviewed in Hong Kong last week, Chu estimated as much as 22 percent of all China’s outstanding credit may be nonperforming by the end of this year, compared with an official bad-loan number for banks in March of 1.75 percent.
What do you see as the biggest risk in the financial system?
“China’s debt problems are large and severe, but in some respects a slow burn. Over the near term, we think the biggest risk is banks’ WMP portfolios. The stock of Chinese banks’ off-balance-sheet WMPs grew 73 percent last year. There is nothing in the Chinese economy that supports a 73 percent growth rate of anything at the moment. Regardless of all of the headlines and announcements about the authorities cracking down on WMPs, they have done very little, really, and issuance continues to accelerate.
“We call off-balance-sheet WMPs a hidden second balance sheet because that’s really what it is — it’s a hidden pool of liabilities and assets. In this way, it’s similar to the Special Investment Vehicles and conduits that the Western banks had in 2008, which nobody paid attention to until everything fell apart and they had to be incorporated on-balance-sheet.
“The mid-tier lenders is where these second balance sheets are very large. China Merchants Bank is a good example. Their second balance sheet is close to 40 percent of their on-balance-sheet liabilities. Enormous.”
Who buys a WMP?
“The products used to be predominantly sold to the public, but now they’re increasingly being sold to banks and other WMPs. We’re starting to see layers of liabilities built upon the same underlying assets, much like we did with subprime asset-backed securities, collateralized debt obligations, and CDOs-squared in the U.S. The range of assets is much more diverse than mortgages, but we have significantly less visibility on the assets than we did with subprime.”
After the People’s Daily commentary, is it clear that the government is serious about deleveraging?
“The word deleveraging should not be used when discussing China. Deleveraging means negative credit growth, or a contraction in the ratio of credit to GDP. China is nowhere close to deleveraging. Over the years, I have learned from watching the authorities respond to issues like WMPs that there is often a large divergence between official rhetoric and actual action. It’s encouraging to see policy makers acknowledge the severe overcapacity problem, but I am sceptical that much headway will be made any time soon, given how painful implementation will be and the pushback they will inevitably receive at local levels.”
Is a financial crisis or a very dramatic economic slowdown now inevitable?
“Not yet, but we’re getting there because the problem is getting so big. We’re still adding 10 to 20 percentage points to the ratio of credit to GDP every year — that has not changed despite the fact that credit growth has decelerated. If the government was to come out with a very aggressive — and it would have to be incredibly aggressive — bailout package for corporates, as well as financial institutions, it would do a lot in terms of dealing with some of this debt overhang and getting rid of the black cloud that’s hanging over the country. However, the idea that China needs a massive bailout in the trillions of U.S. dollars isn’t something I think the authorities are on board with or accept yet. They still believe they can grow out of it.”
Could your assessment of China’s debt situation be based on faulty assumptions?
“If we’re wrong, and there’s always a chance of that, it’s going to be because we’re under-appreciating the economic growth potential in China — that there is some more strength to the consumption story and services story than we sense now, and that these are about to take off and propel the country out of these debt problems.”
How does China’s debt build-up compare to Japan’s previously?
“If you look at Japan, the credit expansion wasn’t anywhere close to the size of China’s, and China’s continues to grow at a rapid rate. There is also a somewhat Wild West, chaotic nature to a lot of the shadow banking going on in China that is different from the shadow credit we saw in Japan. What’s positive for China is that they’ve got a leadership team that is not as afraid as the Japanese leadership is of radical change. So, if China’s authorities ever do decide debt is the center of their problems and they need to do something about it, we won’t have decades of complacency with nothing really done. On the negative side, China has a much weaker social safety net and a much poorer population, which makes social and political instability a real concern.”
What’s your assessment of China’s capital flows?
“The party line is that outflows are all about offshore debt repayment, but that accounts for a minority of the flows we are seeing. We think most of the money is leaving through trade mis-invoicing, which is very hard to shut down. Although capital outflows have quieted down, the underlying motivations for people to move their money out of the country are still there. This problem has not gone away.”
Oil Posts 2% Gain for the Week Despite India Virus Surge
Oil prices steadied on Friday and were set for a weekly gain against the backdrop of optimism over a global economic recovery, though the COVID-19 crisis in India capped prices.
Brent crude futures settled 0.28% higher at $68.28 per barrel and U.S. West Texas Intermediate (WTI) crude advanced 0.29% to $64.90 per barrel.
Both Brent and WTI are on track for second consecutive weekly gains as easing restrictions on movement in the United States and Europe, recovering factory operations and coronavirus vaccinations pave the way for a revival in fuel demand.
In China, data showed export growth accelerated unexpectedly in April while a private survey pointed to strong expansion in service sector activity.
However, crude imports by the world’s biggest buyer fell 0.2% in April from a year earlier to 40.36 million tonnes, or 9.82 million barrels per day (bpd), the lowest since December.
In the United States, the world’s largest oil consumer, jobless claims have dropped, signalling the labour market recovery has entered a new phase as the economy recovers.
The recovery in oil demand, however, has been uneven as surging COVID-19 cases in India reduce fuel consumption in the world’s third-largest oil importer and consumer.
“Brent came within a whisker of breaking past $70 a barrel this week but failed at the final hurdle as demand uncertainty dragged on prices,” said Stephen Brennock at oil brokerage PVM.
The resurgence of COVID-19 in countries such as India, Japan and Thailand is hindering gasoline demand recovery, energy consultancy FGE said in a client note, though some of the lost demand has been offset by countries such as China, where recent Labour Day holiday travel surpassed 2019 levels.
“Gasoline demand in the U.S. and parts of Europe is faring relatively well,” FGE said.
“Further out, we could see demand pick up as lockdowns are eased and pent-up demand is released during the summer driving season.”
Lagos Commodities and Futures Exchange to Commence Gold Trading
With the admission of Dukia Gold’s diversified financial instruments backed by gold as the underlying asset, Lagos Commodities and Futures Exchange is set to commence gold trading.
According to Dukia Gold, the instruments will be in form of exchange-traded notes, commercial papers and other gold-backed securities, adding that it will enable the company to deepen the commodities market in Nigeria, increase capacity, generate foreign exchange for the Nigerian government to better diversify foreign reserves and create jobs across the metal production value chain.
Tunde Fagbemi, the Chairman, Dukia Gold, disclosed this while addressing journalists at Pre-Listing Media Interactive Session in Lagos on Thursday.
He said, “We are proud to be the first gold company whose products would be listed on the Lagos Futures and Commodities Exchange. The listing shall enable us facilitate our infrastructure development, expand capacity and create fungible products.
“This has potential to shore up Nigeria’s foreign reserve and create an alternative window for preservation of pension funds. A gold-backed security is a hedge against inflation and convenient preservation of capital.”
“As a global player, we comply with the practices and procedures of London Bullion Market Association and many other international bodies. Our refinery will also have multiplier effects on the development of rural areas anywhere it is located,” he added.
Mr Olusegun Akanji, the Divisional Head, Strategy and Business Solutions, Heritage Bank, said the lender had created a buying centre for verification of quality and quantity of gold and reference price to ensure price discovery in line with the global standard.
Oil Nears $70 as Easing Western Lockdowns Boost Summer Demand Outlook
Oil prices rose for a third day on Wednesday as easing of lockdowns in the United States and parts of Europe heralded a boost in fuel demand in summer season and offset concerns about the rise of COVID-19 infections in India and Japan.
Brent crude rose 93 cents, or 1.4%, to $69.81 a barrel at 1008 GMT. U.S. West Texas Intermediate (WTI) crude rose 85 cents, or 1.3%, to $66.54 a barrel.
Both contracts hit the highest level since mid-March in intra-day trade.
“A return to $70 oil is edging closer to becoming reality,” said Stephen Brennock of oil broker PVM.
“The jump in oil prices came amid expectations of strong demand as western economies reopen. Indeed, anticipation of a pick-up in fuel and energy usage in the United States and Europe over the summer months is running high,” he said.
Crude prices were also supported by a large fall in U.S. inventories.
The American Petroleum Institute (API) industry group reported crude stockpiles fell by 7.7 million barrels in the week ended April 30, according to two market sources. That was more than triple the drawdown expected by analysts polled by Reuters. Gasoline stockpiles fell by 5.3 million barrels.
Traders are awaiting data from the U.S. Energy Information Administration due at 10:30 a.m. EDT (1430 GMT) on Wednesday to see if official data shows such a large fall.
“If confirmed by the EIA, that would mark the largest weekly fall in the official data since late January,” Commonwealth Bank analyst Vivek Dhar said in a note.
The rise in oil prices to nearly two-month highs has been supported by COVID-19 vaccine rollouts in the United States and Europe.
Euro zone business activity accelerated last month as the bloc’s dominant services industry shrugged off renewed lockdowns and returned to growth.
“The partial lifting of mobility restrictions, the expectation that tourism will return in the near future, and the lure of the psychologically important $70 mark are all likely to have contributed to the price rise,” Commerzbank analyst Eugen Weinberg said.
This has offset a drop in fuel demand in India, the world’s third-largest oil consumer, which is battling a surge in COVID-19 infections.
“However, if we were to eventually see a national lockdown imposed, this would likely hit sentiment,” ING Economics analysts said of the situation in India.
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