It was a rare moment of candor from a policymaker in Beijing when the governor of the People’s Bank of China admitted that weaknesses in some economic regions in northern and western China may face “difficulties in repaying local government debts.”
Main Concern: China’s Troubled Real Estate Sector
The main concern, of course, is China’s troubled real estate sector, which poses a threat resembling Japan’s bad debt crisis in the 1990s. There is hidden debt that Moody’s is worried about, which neither its analysts nor Wall Street investors nor Asian government ministries can get a clear answer on.
Hidden Debts and Structural Challenges
These hidden bonds may exist in the financial statements of many government-backed entities vital for infrastructure development. They are accumulated through municipalities issuing local government financing vehicles, which often lack transparency. There are also multi-layered financing schemes supported by the People’s Bank of China.
Government Moves and Monetary Stimulus
Now, add to that signs that Xi’s government is prioritizing financial and monetary stimulus over structural reform – a sign that China may have reached its limit for dealing with debt problems.
One of these rare moments of candor was the recent admission by the governor of the People’s Bank of China that weaknesses in some economic regions in northern and western China may face “difficulties in repaying local government debts.” This was an extremely rare moment of frankness from a prominent policymaker in Beijing.
Pressure on Major Banks and Real Estate Developers
Also concerning is that Beijing is increasing pressure on the world’s largest banks – state-owned institutions – to support real estate developers facing the risk of default. This is to ensure that developers can complete residential complexes and apartments under construction.
While one could argue that the ends justify the means, this “dangerous step could raise concerns about national service risks and medium-term credit risks,” economists at JPMorgan Chase & Co. warned.
Historical Challenges and Growing Debt
It is even more concerning when viewing this moment through the lens of historical precedent.
China Evergrande Group had over $300 billion in liabilities when it defaulted on its debt obligations in 2021. It has until the end of January to prepare a restructuring plan to avoid liquidation.
“The credit-to-GDP ratio for the non-financial private sector in China has now risen well above the peaks of Japan and South Korea during their private debt bubbles,” according to Diana Choyleva at Enodo Economics. “China is in uncharted territory. Korea has recently approached China, but that poses a problem for Korea rather than providing comfort to China.”
It is also notable that “China is in a state of negative inflation,” according to Choyleva. She added that the official GDP inflation index declined in the second and third quarters by an average of 1.5%.
Choyleva notes that there have only been three occasions when China’s inflation index – a measure of price changes for all goods and services – was negative for two consecutive quarters: the 1997 Asian financial crisis, the 2008 global downturn, and the summer of 2015 when Shanghai stocks fell sharply.
Choyleva also states that “China now has less financial flexibility than the U.S. and U.K. during the global downturn. It is on par with the Eurozone and less constrained than Japan.”
Current Challenges and Future Prospects
In recent years, Xi’s team has prioritized leverage. However, this higher goal of controlling the debt-to-GDP ratio in Beijing collides with a weak recovery post-COVID-19. The effects of Xi’s pandemic closures have turned the major real estate sector into a state of turmoil. Xi’s crackdown on Big Tech, which began in 2020, raised concerns among foreign investors.
Responded
China is forcefully responding to Moody’s news. State media denied the threat of a downgrade as “biased.” It is the same word that then-Finance Minister Lou Jiwei used in 2016 after S&P Global lowered its outlook for Beijing.
But it would be foolish not to read Beijing’s position in the global context here, just as Tokyo failed to read it in the past. The problem is the sense of invincibility among Japanese officials who believe that reckoning will never come. When it did happen, Japan spent years downplaying it, walking in a deep sleep toward inflation.
Will China avoid this fate? Of course, the largest economy in Asia has, and continues to be, managed by some smart, highly skilled damage control specialists. But if China successfully avoids crashing into a financial wall, it will have essentially beaten the system, so to speak.
No industrialized nation or region has yet managed to face a serious reckoning. Not the United States, nor Europe, nor Russia, nor Latin America, nor Southeast Asia, nor Japan. Let’s hope China can break this cycle. If it doesn’t, the global financial system is set for an unprecedented shock.
William Pesek
Source: https://www.forbes.com/sites/williampesek/2023/12/10/moodys-wonders-if-chinas-debt-troubles-echo-bubble-era-japan/
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