November 3, 2008
Despite China's seeming economic might, it was only a few years ago that the hidden losses in among its banks were a frequent subject of discussion in the Western press. Indeed, in 2006, Ernst & Young hastily withdrew a detailed report that estimated that bad debt losses among Chinese banks were well above prevailing assumptions, and the volte face, clearly the result of official pressure, was viewed with considerable skepticism. But from then onward, discussion of the fragility of the Chinese financial system appeared to retreat to the background.
Those concerns may be coming to the fore again as the credit crunch hits China, and banks start to be saddled with real estate losses. The trigger is not residential mortgages (mortgages are not widely used and LTVs are much lower than in most Western countries) but loans to developers.
The article does not mention a second risk, highlighted by Brad Setser: China has experienced a huge influx of hot money seeking to benefit from the appreciation of the RMB. If these expectations fail to be met (CICC is forecasting that the RMB will fall slightly versus the dollar next year rather than continue to rise), some of this hot money will flee. Even for a country with China's massive FX reserves, a shift of that magnitude would be destabilizing.
From Stratfor (hat tip reader Marshall, subscription required)
The People’s Bank of China (PBoC) predicted Oct. 31 that in the coming two years housing prices would slide by 10 percent to 30 percent and that the market would not begin to recover until 2010. Even more important, the bank also publicly revealed its worries about a liquidity crunch among real estate companies and banks.
Thus far into the global financial crisis, China has appeared calm and in control, with all the assurance of a country sitting on $1.9 trillion worth of foreign currency reserves with which to provide liquidity should credit run short. The assumption has been that China is mostly insulated from the credit crunch and that the major threat to its economy is only in the form of the knock-on effects of the credit crisis on China’s crucial export sector...
Stratfor has seen anecdotes, from problems with trade credits to issues related to the real estate sector, suggesting that the image of China being insulated from the global crisis is in part a fabrication by the Chinese government...
The Oct. 31 announcement by the PBoC is the first official acknowledgment that China could be facing a domestic credit crunch. The bank’s predictions suggest not only that real estate prices are dropping drastically because of falling demand but also that the effect on real estate companies, especially in urban areas, is now amounting to tightened capital flows. Moreover, the PBoC warned that the situation poses “a relatively large risk” to the commercial banks that have made loans to the construction and development companies because these companies use property as collateral and their collateral is now losing value. Anywhere from 20 percent to 40 percent of the total loans granted by these commercial banks have been devoted to the real estate sector, according to the PBoC.
The prospect of China seeing urban real estate bubbles burst and developers and lenders fail is a cause of great concern among authorities. If the prospect comes true it could have dire consequences for the world’s fourth-largest economy.
China’s domestic economy depends on subsidized, below market rate credit to maintain rapid growth rates and employment. If a credit crunch strikes in China, it would be unusual and unintended, and the system might not be fully prepared to cope with it. The central government is likely to act quickly with its reserves to prevent emerging liquidity shortages from spreading, but as we have already seen in the West, credit crunches have a way of getting out of control.
ETFs/Stocks :
- iShares FTSE/Xinhua China 25 Index (FXI) 27.21 +1.76 (6.92%)
UltraShort FTSE/Xinhua China 25 ProShares (FXP) 75.20 -10.80 (-12.56%)
Sources :
- Naked Capitalim: China Faces Liquidity Crunch, November 3, 2008
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