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China’s Credit Bubble Unprecedented

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Whereas China may have helped to save the world in 2008, its ability to help global GDP has slowly been strangled by its own massive debt levels. Corporate and private sector debt has grown out of all proportions severely limiting China’s ability to grow its way out of its debt problems.  It’s not just Western banks we need worry about.

China’s shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned. Fitch warned that wealth products worth $2 trillion of lending are in reality a “hidden second balance sheet” for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.

The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead.

“The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation,” said Charlene Chu, the agency’s senior director in Beijing.

“There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signalling,” she told The Daily Telegraph.

While the non-performing loan rate of the banks may look benign at just 1pc, this has become irrelevant as trusts, wealth-management funds, offshore vehicles and other forms of irregular lending make up over half of all new credit. “It means nothing if you can off-load any bad asset you want. A lot of the banking exposure to property is not booked as property,” she said.

Concerns are rising after a string of upsets in Quingdao, Ordos, Jilin and elsewhere, in so-called trust products, a $1.4 trillion segment of the shadow banking system.

Bank Everbright defaulted on an interbank loan 10 days ago amid wild spikes in short-term “Shibor” borrowing rates, a sign that liquidity has suddenly dried up. “Typically stress starts in the periphery and moves to the core, and that is what we are already seeing with defaults in trust products,” she said.

Fitch warned that wealth products worth $2 trillion of lending are in reality a “hidden second balance sheet” for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.

This niche is the epicentre of risk. Half the loans must be rolled over every three months, and another 25pc in less than six months. This has echoes of Northern Rock, Lehman Brothers and others that came to grief in the West on short-term liabilities when the wholesale capital markets froze.

Mrs Chu said the banks had been forced to park over $3 trillion in reserves at the central bank, giving them a “massive savings account that can be drawn down” in a crisis, but this may not be enough to avert trouble given the sheer scale of the lending boom.

Overall credit has jumped from $9 trillion to $23 trillion since the Lehman crisis.

“They have replicated the entire US commercial banking system in five years,” she said.

The ratio of credit to GDP has jumped by 75 percentage points to 200pc of GDP, compared to roughly 40 points in the US over five years leading up to the subprime bubble, or in Japan before the Nikkei bubble burst in 1990. “This is beyond anything we have ever seen before in a large economy. We don’t know how this will play out. The next six months will be crucial,” she said.

The agency downgraded China‘s long-term currency rating to AA- debt in April but still thinks the government can handle any banking crisis, however bad. “The Chinese state has a lot of firepower. It is very able and very willing to support the banking sector. The real question is what this means for growth, and therefore for social and political risk,” said Mrs Chu.

“There is no way they can grow out of their asset problems as they did in the past. We think this will be very different from the banking crisis in the late 1990s. With credit at 200pc of GDP, the numerator is growing twice as fast as the denominator. You can’t grow out of that.”

The authorities have been trying to manage a soft-landing, deploying loan curbs and a high reserve ratio requirement (RRR) for banks to halt property speculation. The home price to income ratio has reached 16 to 18 in many cities, shutting workers out of the market. Shadow banking has plugged the gap for much of the last two years.

However, a new problem has emerged as the economic efficiency of credit collapses. The extra GDP growth generated by each extra yuan of loans has dropped from 0.85 to 0.15 over the last four years, a sign of exhaustion.

Wei Yao from Societe Generale says the debt service ratio of Chinese companies has reached 30pc of GDP – the typical threshold for financial crises — and many will not be able to pay interest or repay principal. She warned that the country could be on the verge of a “Minsky Moment”, when the debt pyramid collapses under its own weight. “The debt snowball is getting bigger and bigger, without contributing to real activity,” she said.

The latest twist is sudden stress in the overnight lending markets. “We believe the series of policy tightening measures in the past three months have reached critical mass, such that deleveraging in the banking sector is happening. Liquidity tightening can be very damaging to a highly leveraged economy,” said Zhiwei Zhang from Nomura.

“There is room to cut interest rates and the reserve ratio in the second half,” wrote a front-page editorial today in China Securities Journal on Friday. The article is the first sign that the authorities are preparing to change tack, shifting to a looser stance after a drizzle of bad data over recent weeks.

The journal said total credit in China’s financial system may be as high as 221pc of GDP, jumping almost eightfold over the last decade, and warned that companies will have to fork out $1 trillion in interest payments alone this year. “Chinese corporate debt burdens are much higher than those of other economies. Much of the liquidity is being used to repay debt and not to finance output,” it said.

It also flagged worries over an exodus of hot money once the US Federal Reserve starts tightening. “China will face large-scale capital outflows if there is an exit from quantitative easing and the dollar strengthens,” it wrote.

The journal said foreign withdrawals from Chinese equity funds were the highest since early 2008 in the week up to June 5, and withdrawals from Hong Kong funds were the most in a decade.

Source: Irish Independent

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Greece Default Update From The Slog

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Last week “The Slog” reported that the Greeks were due to officially be declared in default by the rating agencies on March 23. Today Fitch downgraded Greece to C from CCC but his sources have since clarified further information:

“The main bond swap is scheduled for March 10,” a Washington insider told me within the last hour, “and at that point, they [Fitch] will name the event as a technical default. So now everyone wants to know what the ramifications are for insurance. That’ll depend on what deal, say, Hedge Funds have signed with specific insurers. But you could certainly speculate that some insurance will be triggered.”

And then to add insult to injury for the Greek people, it looks like their general election is to be postponed.

Meanwhile, following the Greek Environment minister’s suggestion that the elections in Greece be further postponed, there is widespread speculation in Athens that Goldman Sachs implant Prime Minister Lucas Papademos is under pressure to announce this formally.

Iceland Upgraded by Fitch

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While eurozone countries such as Greece and Ireland etc embrace austerity and repay bondholders, Iceland who told the banks to f&*K off have now been rewarded by Fitch Ratings agency for correctly doing the right thing. It now has reached investment grade BBB and has successfully exited its IMF programme. Remember in October, the country held a conference to show the lessons learnt. They are now experiencing a lowering of unemployment figures and economic growth. In fact even the IMF had this to say

As the first country to experience the full force of the global economic crisis, Iceland is now held up as an example by some of how to overcome deep economic dislocation without undoing the social fabric.

Ambrose Evans Pritchard writes the following

Fitch has upgraded the country to investment grade BBB – with stable outlook, expecting government debt to peak at 100pc of GDP.

The OECD’s latest forecast said growth will be 2.4pc this year, after 2.9pc in 2011.

Unemployment will fall from 7pc last year to 6.1pc this year and then 5.3pc in 2013.

The current account deficit was 11.2pc in 2010. It will shrink to 3.4pc this year, and will be almost disappear next year.

The strategy of devaluation behind capital controls has rescued the economy. (Yes, I know there is a dispute about exchange controls, but that is a detail.) The country has held its Nordic welfare together and preserved social cohesion. It is slowly prospering again, though private debt weighs heavy.

and according to Fitch themselves

Iceland has been among the front runners on fiscal consolidation in advanced economies: the primary deficit has contracted from 6.5% of GDP in 2009 to 0.5% in 2011 and Iceland appears to be on track to attain primary fiscal surpluses from 2012 and headline surpluses from 2014. Fitch believes that gross general government debt may have peaked at around 100% of GDP in 2011 (excluding potential Icesave liabilities); net debt is significantly lower at around 65% of GDP, reflecting appreciable deposits at the Central Bank (CBI). Barring further shocks, Iceland should see a sustained reduction in its public debt/GDP ratio from 2012, assuming economic recovery continues and the government adheres to its medium term fiscal targets. Ample general government deposits at the CBI and record foreign exchange reserves.

However, it’s not all rosy for Iceland. There is still an EFTA court ruling on Icesave and this could raise public debt by 6%-13% of GDP. Capital control have blocked the repatriation of some deposits. Household debt exceeds 200% of disposable income and corporate debt 210% of GDP. But as Iceland struggles, it’s certainly on the right path and showing the way. The moral of the story is “tell the Banks to F**K OFF”.        😉

 

No Solution For Euro Says Fitch Ratings Agency

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Edward Parker of ratings agency Fitch gave a speech in Madrid yesterday and admitted that they believe

a comprehensive solution to the eurozone crisis is “technically and politically beyond reach.”

Fitch said it came to this conclusion after the EU summit on December 9, 10, as it prepares to downgrade Ireland and five other eurozone states.

As a consequence of Fitch’s views on the euro being unresolved, it plans a spate of sovereign downgrades this month which follows on from S&P who last week downgraded a number of countries. This spells further bad news for the eurozone leaders plans to bring calm to the situation.

the agency was likely to cut the ratings of six euro nations by the end of this month. Fitch, the third-largest rating agency, placed Belgium, Cyprus, Ireland, Italy, Slovenia and Spain on “negative” watch in mid-December, after the summit.

Source: Irish Independent

 

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