China has to solve a 13 trillion dollar local debt problem
So far, China has tackled its local government debt problem with a mix of measures such as extending maturities and cutting interest rates . But now the 13 trillion dollar mega-debt seems to no longer be able to be tackled with impromptu measures, according to the official China Daily newspaper. This is a figure equal to 4 times all the Italian public debt…
However, the attempts made so far have put the banking system to an ever greater strain, with an inevitable compression of profits. Beijing may soon face a choice between bailing out local governments and preserving a healthy banking system or facing a mass default and potential financial instability.
According to Goldman Sachs estimates, Chinese banks have an exposure of 94 trillion yuan ($13 trillion) in local government debt, or about 29% of total assets. Even assuming a constant default rate – and this is a big if – the US broker still expects a deterioration in bank profits in the coming years. Lending rates are falling on both new and renewed public debt, resulting in worsening financial metrics such as net interest margin and equity yields.
A Bloomberg report on Monday illustrated the situation perfectly: Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp. are now offering 25-year loans to selected local government financing vehicles, as opposed to the 10-year standard for business loans . Some agreements even provide for a waiver of payment in the first four years, even if the interest accrues later, according to people familiar with the matter. At least eccentric forms of loan.
Between 2023 and 2025, the effective interest rate on local government debt is projected to decline on average about 30 percentage points per year, resulting in an average annual decline in ROE of 100 percentage points, according to a July 4 report. by Shuo Yang, an analyst at Hong Kong-based Goldman Sachs (Asia) LLC. With earnings under pressure, Chinese banks are failing to maintain a healthy balance between adequate NPL provisioning, adequate capital base and high dividend payouts, Yang concluded. Things would be even worse if default rates were to rise, because banks would not have the profits to build up the necessary provisions.
Eliminating dividends might seem like the easier choice, compared to the potential financial risks of bad debt or inadequate capital. However, that would be dire news for markets at a time when the Hang Seng China Enterprise Index lags nearly every major indicator in the world. It will also be a slap in the face to politicians, who a few months ago pushed state-owned enterprises to improve ROE and value creation.
Domestic and foreign economists have called – so far unsuccessfully – on the central government to expand its lending and tackle the local debt problem. If Beijing insists on bailouts and forces local authorities to resolve its debt problems, it could face not only mass defaults but also banking crises in the years to come.
Can the Chinese government afford it?
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The article China must solve a 13 trillion dollar local debt problem comes from Scenari Economics .
This is a machine translation of a post published on Scenari Economici at the URL https://scenarieconomici.it/la-cina-deve-risolvere-un-problema-di-debito-locale-per-13-mila-miliardi-di-dollari/ on Sat, 08 Jul 2023 06:00:00 +0000.