Wednesday, May 27, 2009

How is China Spending their Stimulus.. and How Many of Their Loans Will Go Bad?

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I think it is incredibly important to focus on China and in fact Chindia (China + India) as I expect the East to have a greater and greater role in the world's future, both economically and otherwise. Many Americans are very inward looking, and my belief has no idea what is coming down the pike - this is very different from the "threat from Japan" that turned out to be a pipe dream in the late 80s. We can already see the growing importance of China these past 3-4 months as they have been one of the stalwarts holding up this global economy with purchases of every conceivable commodity [May 13, 2009: Commodities - It's China's World: We Just Live in It] ... when they decide it's time to buy copper, the commodity soars [Mar 23, 2009: FT.com - Chinese Stockpiling Spurs Copper Price Rally], same with iron ore (and hence the Baltic Dry Index) [Feb 9, 2009: China and the Baltic Dry Index - What's Really Going On?] , same with oil [Mar 9, 2009: Reuters - China Government Oil Reserve Full] Frankly a lot of old sign posts have become useless as China demand has overwhelmed natural ebb and flows of supply and demand.

Aside from that the Chinese are our main drug ... err, debt dealers [May 21, 2009: NYT - China Becoming More Picky About Debt] and I propose as the creditor of 2nd to last resort (after the Federal Reserve) when they say jump, we are increasingly forced to listen - see the nationalization of FanFredron (Fannie & Freddie) last fall days after Chinese said they wanted their investments safeguarded.

While there was much clucking about our Congressional directed "stimulus" - much of which won't hit until 2010 and little is true "infrastructure investment", the Chinese showed (for better or worse) how to get money into the economy ... and fast. [Mar 17, 2009: NYT - In China's Stimulus Spending, Seeds of Surge] We wrote in February how China was essentially stealing the playbook from the American central bankers post Volcker era and loan growth was being forced through the banks at a historic pace [Feb 16 2009: Is China Pulling an Alan Greenspan?]

Some very interesting data out of China of late in terms of loan growth - in fact staggering data. Before I write the rest of this entry don't take it as bashing the Chinese. In fact they are learning from the masters of manipulation - the United States. They are following the Greenspan playbook - to forestall a normal economic cycle flood the system with dollars... which creates new bubbles. But now we see China is embarking on the same game plan - which in the long run will lead to bad outcomes, but in the short(er) run can goose values.

Chinese banks extended a record 1.62 trillion yuan ($237 billion) in loans in January,
more than double the year before, as lenders heeded government calls to loosen credit controls to help revive the economy. Facing an abrupt slowdown due to plunging demand for China's exports, regulators have sought to boost liquidity after years of trying to rein in lending. Banks made 771.8 billion yuan ($113 billion) in new loans in December, figures show, up nearly 15 fold over the same month a year before.

As a reminder as pundits throughout the American universe were calling for the very narcissistic view of "first in, first out, USA! USA! USA!" last summer in terms of how this slowdown (remember, it was NOT a recession last summer - can't say the word ahead of a national election) would resolve itself, we were of the mind that Asia, esp. China would lead the world out. But I think the current fervor is premature as people now expect some sort of worldwide miracle from the equivalent of half a billion US dollars in China. I think other major economies need to be much farther along in their recovery before China can help drag them up. And China's "middle class" is only so large, and only so many can "consume" to create internal demand at this time - so it's a matter of scale. That said, this is my opinion which can always be wrong and more important it really does not matter what the truth is in the stock market; it only matters what the perception of truth is by the herd. So the same herd who last year fed us "The US will lead us to salvation" has now switched to "China will lead us to salvation". Whatever is convenient for driving up stocks I suppose.

Now with all that said, China is not without problems and I'll be interested to see where things stand in about 6 months. They seem to be in a "build it, build anything" mode with loans flying out the wazoo to combat a slump in both exports and imports [Jan 13, 2009: AP - China Trade Slump Worsens; Exports Fall - So Do Imports] and I do believe they realize that they cannot pin all their hopes simply on indebted US consumers to use their house ATMs for the next 20 years in lieu of actual savings. [Jan 8, 2009: NYT - As Trade Slows, China Rethinks Its Growth Strategy] The current thesis is somehow the Chinese consumer, with high savings rates and lack of social safety net is going to jump with glee into an American like spending orgy [Dec 7, 2008: NYT - China's Economy, In Need of Jump Start, Waits for Citizens to Loosen Fists] - is that plausible? Hardly. But you don't need a plausible thesis to drive up stocks; just a good fairy tale. Err... sorry, a good story. And you need to ignore the bad data points (remember they are backwards looking) while smiling as you speak joyfully of recoveries (preferably in Mandarin). [Apr 13, 2009: China - Some Good, Some Bad; Market Participants Focus on Good]

Recall just last week we pointed out some analysts were already pointing out a potential slowdown coming in the Chinese economy as the export markets remain moribund and the sugar high from government spending that are stoking factories begins to wear off. [May 21, 2009: Credit Suisse Joins Others in Call: China's Recovery Stalling] Perhaps Stimulus 2.0 will be on the docket by the next winter.

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So with that background, I wanted to look at 2 specific stories - first, while no one seems to care except me, I am curious how many of these loans will go bad. Because as the US so aptly showed - when you make money easy, and banks lend to anything that moves ... well let's just say there is some fallout to that. And second, where exactly (at least per the Chinese) is this stimulus money going? Both are very interesting situation considering one of the most prominent economists at a GOVERNMENT think tank is saying property prices are to halve in China as they have a bubble already.... yet China is "building more stuff" on top of that. [Apr 15, 2009: FT.com - Chinese Property Prices to Halve in Next 2 Years]

Property prices in China are likely to halve over the next two years, a top government researcher has forecast, in a strong sign that the country's economic downturn faces further challenges in spite of recent positive data.

Cao Jianhai, professor at the Chinese Academy of Social Sciences, a government think-tank, said a rebound in the property market was unsustainable and driven by a flood of liquidity and fraudulent activity rather than real demand.

"
Prices may not fall in the near term but I expect a collapse starting next year, followed by many years of stagnation," he said. Mr Cao is known as one of the "three swordsmen" of real estate because of his influence as an official economist.


Before I move to the pieces, let me say even if many bad things happen down the road from the actions of today - it really does not matter to "the market". "The market" is only concerned about finding a short term speculative profit in the near term, so it is clapping with both hands (and feet) for money to be thrown in every direction to create new bubbles. No matter the ultimate outcome - did you hear any whining as "the market" went ever upward in 2003-fall 2007? But I just want readers to see the whole mosaic... there seems very little cost benefit analysis happening anymore in any venue. It's all about benefits, and costs are to be thought about "some other time".

First, from the Wall Street Journal: Fitch Sounds Alarm on Chinese Lenders

As we read this remember, the Indian and Chinese banks were considered in good shape (on a relative basis) because they were shielded from the Western world and its virus, along with going the complete opposite route of "free markets solve everything" - i.e. actually having regulators who do their job and press BACK against banking executives. [Dec 28, 2008: NYT - How India Avoided the Crisis] In fact, my favorite quote in October 2007 as US markets were at all time highs and the same pundits who scream recovery today were telling us there would not even be a recession because "the market" is all knowing (and forecasting great things to come in 4-6 months) and "smart money" was buying our "innovative" banks on the first major dip, was this one:

Emerging markets are being favored in part because "financial innovations are less common in developing countries," said Heidemarie Wieczorek-Zeul, German economics minister, in remarks to the IMF/World Bank Development Committee.

Anyhow I love dogma as long time readers will know... let's get back to China....
  • Credit-ratings firm Fitch Ratings says China's banks are showing early signs of asset-quality deterioration amid a torrent of lending to help fund government stimulus projects. New loans totaling 5.17 trillion yuan, or $757.5 billion, in the first four months of this year have already exceeded the 4.91 trillion yuan in loans made in all of 2008.
  • Amid the credit surge, government officials have warned of rising risks. Earlier this week, they announced rules to ensure money is going to the real economy, amid concerns that some loans were being diverted into the asset markets instead.
  • Fitch said it is seeing warning signals from the Chinese banking system. Chinese lenders have been downgrading more "special mention" loans, those that are considered about to default, to nonperforming status, marking them as bad debt.
  • Chinese banks also have been increasing provisions for losses on unimpaired loans, indicating that "the banks themselves see greater losses down the line in loans that are currently performing," Ms. Chu said.
  • Fitch has long argued that figures such as low levels of nonperforming loans compared with total bank assets don't tell the full story. It has pointed to items such as special-mention loans and a lack of transparency in the way banks categorize loans as poorly recognized risks. The latest report notes that the credit boom, coupled with the poor economy, is exacerbating those risks.
  • Fitch said any impending credit crisis will be hard to spot in the short term given the high volume of lending. China's banks tend to roll over loans, or extend their maturities, when debts come due, distorting any assessment of lenders' asset quality, Ms. Chu told analysts Thursday. Over time, though, the global economy's weakness and China's still-nascent domestic demand will take a toll on the banks, as corporate borrowers earn less and the likelihood of defaults rises, she said.
  • The report also noted that nonperforming-loan ratios at China-based foreign banks, usually thought to have higher risk-management standards than Chinese banks, have been rising.
Not that US banks are transparent but I can imagine how hard it would be to make a clear assessment of the Chinese banks. The last point above is probably a better clue - the somewhat "less" opaque China based foreign banks (with higher risk management standards and not under the thumb of government) are seeing increased issues. So this is an issue to keep an eye on... but does it matter? Certainly not in the short run and certainly not to market participants happy to see demand and green shoots created (benefits) no matter what (costs)... since costs always come later.

Next let's move on to how exactly the stimulus money is supposedly being spent... the Wall Street Journal has a blog section devoted just to China so I was excited to find that, and this story perked my virtual ears: Spending the Stimulus - Where China's Money is Going
  • China’s National Development and Reform Commission has issued a status report on the spending of the nation’s 4 trillion yuan ($486 billion) economic stimulus package. As of April 30, 230 billion yuan of new funding from the central government had been spent, and the NDRC has issued a list of the types of projects that are benefiting from the stimulus money. (It should be noted that 70% of the stimulus funding is supposed to come from non-central sources, such as local governments and bank lending).
  • As is often the case with government figures, they alternate between the highly specific (”273 pieces of grain-drying equipment” ) and the substantially less so (”speeding up the work on the South-North Water Transfer Project,” which has been under way since 2002).
1. Housing: China’s stimulus plan allocates 400 billion yuan (10% of the total stimulus) to the construction of low-income housing, upgrading shanty towns and other measures to improve housing conditions.
  • Basically completed: 210,000 units of low-income housing.
  • Under construction: 650,000 units of low-income housing, 8,500 units on state-owned reclaimed land and 18,000 fixed homes for nomadic peoples.
  • Renovations: Work has been sped up on improvements to 100,000 homes in coal-mining shanty towns, 129,000 homes in areas subject to caving in as a result of coal mining and 157,000 shanty town homes on state-owned forest areas.
2. Rural Development: Basic village infrastructure and civil engineering projects, such as providing water, electricity and gas to rural areas will account for 370 billion yuan (or 9.25%) of stimulus spending.
  • Completed: 20,000 kilometers of roads, 254 rural electricity substations, 30,000 kilometers of power lines, 2.6 million mu (416,000 acres) of standardized grain fields, 5,000 programs to prevent animal epidemics. Purchased and installed 13,427 pieces of equipment to test the quality of rural products, 280,000 pieces of equipment to test food quality and safety, 273 pieces of grain-drying equipment and added 350,000 tons of edible oil storage capacity. Established 172 poverty relief and food-for-work programs, upgraded 700 postal routes, and resolved the problem of potable water for 14.6 million people.
  • Basically completed: 450 major water conservancy projects, 290 projects to improve the water quality in unsafe medium-to-large reservoirs, 193 large scale irrigation and water conservancy projects. Under construction: 1.6 million village methane pits.
  • Accelerated: Construction on the South-North Water Transfer Project.

3. Major Infrastructure. This area are set to receive the largest chunk of stimulus spending - 1.5 trillion yuan, or 37.5% of the total. Projects include railroads, highways, airports, other large-scale basic infrastructure and an upgrade of the urban electricity grids.
  • Completed: 445 kilometers of expressway, 100,000 square meters of passenger airport terminals.
  • Accelerated: Construction of the Harbin-Dalian, Wuhan-Guangzhou, Nanjing-Guangzhou and Guiyang-Guangzhou railroads, upgrading of the urban electricity grids.
4. Health Care, Education, Culture: Social development projects get 150 billion yuan (3.75%).
  • Completed: 900,000 square meters of mid-level vocational school buildings.

  • Basically completed: 1,246 township cultural stations, 6,500 basic health care-projects, 1,140 one-child policy service projects and six cornerstone Chinese medicine hospital projects.

  • Renovated: 1.5 million square meters of elementary and junior-high school buildings.


5. Environment: Energy saving, emissions reduction and ecological construction projects are allocated 210 billion yuan (5.25%).
  • Completed: Sewage treatment capacity increased by 2.8 million tons per day, garbage processing capacity increased by 3,155 tons per day, 320,000 tons of chromium residue processed, 2,548 kilometers of pipes laid, chemical oxygen demand reduced by 65,000 tons. Also created the capacity to conserve 6.2 million tons of standard coal, 120 million tons of water, and to recycle 2.7 million tons of waste. Accelerated: Planting of 29 million mu (4.6 million acres) of forest land.

6. Industry and Technology: China has allocated 370 billion yuan (9.25% of the total stimulus) to fund independent innovation and industrial restructuring.
  • Accelerated: 176 high-tech industrialization projects and 146 projects to advance industrial technology selected for investment by the central government last year.

  • Issued: This year’s plan to invest in 222 projects to promote the electronic information industry and upgrade technology.


7. Post-quake Reconstruction: One trillion yuan (25% of the stimulus) is to be spent on rebuilding areas hit by last year’s Sichuan earthquake.
  • No details were provided on spending in this area.
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Say what you will but this sounds a lot more like the Obama "framework" for our (mostly) wasted tax dollars ("infrastructure") before Congress got it's paws in it. Granted, in both countries much will go to graft but at least directionally what the Chinese are doing is mostly "investing" rather than "spending for spending sake". It is interesting that 1 of every 4 yuan is going simply to rebuild Sichuan after the traumatic earthquake. And nearly 40% is going for major infrastructure - roads, railroads, airports, et al.

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