The China syndrome: Danger areas, banking performance and China’s ability to respond

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According to Fitch Ratings, China faces a 60% chance of a systemic banking crisis by mid-2013, given credit growth estimated to exceed 15% annually over two years and real property prices estimated to rise more than 5%. In November 2010, Moody’s flagged concerns over the ‘intrinsic, stand-alone strength of China’s banking system’. Citigroup highlighted growing Chinese residential property investments, 6.1% of 2010 GDP, matching the US subprime bubble in 2005, and about 2% below Japan’s 1970s housing boom.

Despite intervention to dampen property inflation, prices in 10 cities out of 17 rose 10% or more, Haikou and Sanya reaching 21.6% and 19.1% respectively. Local governments are barred from borrowing directly, but US $300bn of loans involving local authority indirect guarantees are problematic. Official studies showed 26 % of the 7.66 trillion yuan lent to local authority finance vehicles by end June 2010 failed to meet regulations, faced "serious default risk", or were embezzled. Full payment was only being made on 24%, with the rest being serviced by local governments or with collateral.

Some key figures:

• Chinese reserves grew $469.6 billion in 2010 to $2.869 trillion (US$3.04 trillion in January 2011), just under triple Japanese reserves (second in the world behind Chinese), at $1.09 trillion in February 2011.

• China’s budget deficit is forecast at $137 billion (900 billion yuan) in 2011, 2.0% of GDP, falling from 2.5% in 2010 and 2.8% in 2009.

• In the prior China banking crisis in 1999/2000, bad loans reached $650 billion and an estimate has suggested this cycle could involve $400 billion.

Given China’s massive reserves, limited international indebtedness, low government debt and modest deficit, even sizeable banking problems are unlikely to swamp China’s economy overall, or come close to matching the problems faced in Europe and the US. If it needs to, China can defend itself by slowing capital outflows to elsewhere.

Brian Lawson is Special Consultant to Exclusive Analysis.