Markets

Massive Bailout’ Needed in China, Banking Analyst Chu Says

Published

8 years ago

May 24, 2016

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.

QUICKTAKE China’s Pain Points

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.

Question

What do you see as the biggest risk in the financial system?

Answer

“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.”

Question

Who buys a WMP?

Answer

“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.”

Question

After the People’s Daily commentary, is it clear that the government is serious about deleveraging?

Answer

“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.”

Question

Is a financial crisis or a very dramatic economic slowdown now inevitable?

Answer

“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.”

Question

Could your assessment of China’s debt situation be based on faulty assumptions?

Answer

“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.”

Question

How does China’s debt build-up compare to Japan’s previously?

Answer

“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.”

Question

What’s your assessment of China’s capital flows?

Answer

“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.”

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Samed Olukoya

Is the CEO/Founder of Investors King Limited. A proven foreign exchange research analyst and a published author on Yahoo Finance, Businessinsider, Nasdaq, Entrepreneur.com, Investorplace, and many more. He has over two decades of experience in global financial markets.

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Crude Oil

Brent Plunges Below $83 Amidst Rising US Stockpiles and Middle East Uncertainty

Published

1 hour ago

May 8, 2024

Samed Olukoya

The global oil declined today as Brent crude prices plummeted below $83 per barrel, its lowest level since mid-March.

This steep decline comes amidst a confluence of factors, including a worrisome surge in US oil inventories and escalating geopolitical tensions in the Middle East.

On the commodity exchanges, Brent crude, the international benchmark for oil prices, experienced a sharp decline, dipping below the psychologically crucial threshold of $83 per barrel.

West Texas Intermediate (WTI) crude oil, the US benchmark, also saw a notable decrease to $77 per barrel.

The downward spiral in oil prices has been attributed to a plethora of factors rattling the market’s stability.

One of the primary drivers behind the recent slump in oil prices is the mounting stockpiles of crude oil in the United States.

According to industry estimates, crude inventories at Cushing, Oklahoma, the delivery point for WTI futures contracts, surged by over 1 million barrels last week.

Also, reports indicate a significant buildup in nationwide holdings of gasoline and distillates, further exacerbating concerns about oversupply in the market.

Meanwhile, geopolitical tensions in the Middle East continue to add a layer of uncertainty to the oil market dynamics.

The Israeli military’s incursion into the Gazan city of Rafah has intensified concerns about the potential escalation of conflicts in the region.

Despite efforts to broker a truce between Israel and Hamas, designated as a terrorist organization by both the US and the European Union, a lasting peace agreement remains elusive, fostering an environment of instability that reverberates across global energy markets.

Analysts and investors alike are closely monitoring these developments, with many expressing apprehension about the implications for oil prices in the near term.

The recent downturn in oil prices reflects a broader trend of market pessimism, with indicators such as timespreads and processing margins signaling a weakening outlook for the commodity.

The narrowing of Brent and WTI’s prompt spreads to multi-month lows suggests that market conditions are becoming increasingly less favorable for oil producers.

Furthermore, the strengthening of the US dollar is compounding the challenges facing the oil market, as a stronger dollar renders commodities more expensive for investors using other currencies.

The dollar’s upward trajectory, coupled with oil’s breach below its 100-day moving average, has intensified selling pressure on crude futures, exacerbating the latest bout of price weakness.

In the face of these headwinds, some market observers remain cautiously optimistic, citing ongoing supply-side risks as a potential source of support for oil prices.

Factors such as the upcoming June meeting of the Organization of the Petroleum Exporting Countries (OPEC+) and the prospect of renewed curbs on Iranian and Venezuelan oil production could potentially mitigate downward pressure on prices in the coming months.

However, uncertainties surrounding the trajectory of global oil demand, geopolitical developments, and the efficacy of OPEC+ supply policies continue to cast a shadow of uncertainty over the oil market outlook.

As traders await official data on crude inventories and monitor geopolitical developments in the Middle East, the coming days are likely to be marked by heightened volatility and uncertainty in the oil markets.

Crude Oil

Oil Prices Climb on Renewed Middle East Concerns and Saudi Supply Signals

Published

2 days ago

May 6, 2024

Samed Olukoya

As global markets continue to navigate through geopolitical uncertainties, oil prices rose on Monday on renewed concerns in the Middle East and signals from Saudi Arabia regarding its crude supply.

Brent crude oil, against which Nigeria’s oil is priced, surged by 51 cents to $83.47 a barrel while U.S. West Texas Intermediate crude oil rose by 53 cents to $78.64 a barrel.

The recent escalation in tensions between Israel and Hamas has amplified fears of a widening conflict in the key oil-producing region, prompting investors to closely monitor developments.

Talks for a ceasefire in Gaza have been underway, but prospects for a deal appeared slim as Hamas reiterated its demand for an end to the war in exchange for the release of hostages, a demand rejected by Israeli Prime Minister Benjamin Netanyahu.

The uncertainty surrounding the conflict was further exacerbated on Monday when Israel’s military called on Palestinian civilians to evacuate Rafah as part of a ‘limited scope’ operation, sparking concerns of a potential ground assault.

Analysts warned that such developments risk derailing ceasefire negotiations and reigniting geopolitical tensions in the Middle East.

Adding to the bullish sentiment, Saudi Arabia announced an increase in the official selling prices (OSPs) for its crude sold to Asia, Northwest Europe, and the Mediterranean in June.

This move signaled the kingdom’s anticipation of strong demand during the summer months and contributed to the upward pressure on oil prices.

The uptick in prices comes after both Brent and WTI crude futures posted their steepest weekly losses in three months last week, reflecting concerns over weak U.S. jobs data and the timing of a potential Federal Reserve interest rate cut.

However, with most of the long positions in oil cleared last week, analysts suggest that the risks are skewed towards a rebound in prices in the early part of this week, particularly for WTI prices towards the $80 mark.

Meanwhile, in China, the world’s largest crude importer, services activity remained in expansionary territory for the 16th consecutive month, signaling a sustained economic recovery.

Also, U.S. energy companies reduced the number of oil and natural gas rigs operating for the second consecutive week, indicating a potential tightening of supply in the near term.

As global markets continue to navigate through geopolitical uncertainties and supply dynamics, investors remain vigilant, closely monitoring developments in the Middle East and their impact on oil prices.

Crude Oil

Oil Prices Drop Sharply, Marking Steepest Weekly Decline in Three Months

Published

4 days ago

May 4, 2024

Samed Olukoya

Amidst concerns over weak U.S. jobs data and the potential timing of a Federal Reserve interest rate cut, oil prices record its sharpest weekly decline in three months.

Brent crude oil, against which Nigerian oil is priced, settled 71 cents lower to close at $82.96 a barrel.

Similarly, U.S. West Texas Intermediate crude oil fell 84 cents, or 1.06% to end the week at $78.11 a barrel.

The primary driver behind this decline was investor apprehension regarding the impact of sustained borrowing costs on the U.S. economy, the world’s foremost oil consumer. These concerns were amplified after the Federal Reserve opted to maintain interest rates at their current levels this week.

Throughout the week, Brent experienced a decline of over 7%, while WTI dropped by 6.8%.

The slowdown in U.S. job growth, revealed in April’s data, coupled with a cooling annual wage gain, intensified expectations among traders for a potential interest rate cut by the U.S. central bank.

Tim Snyder, an economist at Matador Economics, noted that while the economy is experiencing a slight deceleration, the data presents a pathway for the Fed to enact at least one rate cut this year.

The Fed’s decision to keep rates unchanged this week, despite acknowledging elevated inflation levels, has prompted a reassessment of the anticipated timing for potential rate cuts, according to Giovanni Staunovo, an analyst at UBS.

Higher interest rates typically exert downward pressure on economic activity and can dampen oil demand.

Also, U.S. energy companies reduced the number of oil and natural gas rigs for the second consecutive week, reaching the lowest count since January 2022, as reported by Baker Hughes.

The oil and gas rig count fell by eight to 605, with the number of oil rigs dropping by seven to 499, the most significant weekly decline since November 2023.

Meanwhile, geopolitical tensions surrounding the Israel-Hamas conflict have somewhat eased as discussions for a temporary ceasefire progress with international mediators.

Looking ahead, the next meeting of OPEC+ oil producers is scheduled for June 1, where the group may consider extending voluntary oil output cuts beyond June if global oil demand fails to pick up.

In light of these developments, money managers reduced their net long U.S. crude futures and options positions in the week leading up to April 30, according to the U.S. Commodity Futures Trading Commission (CFTC).