In a classic case of procrastination, China has been keeping its massive debt crisis at bay by issuing more debt. However, Fitch’s Charlene Chu, a leading expert on China’s debt, thinks the country’s time is up. “The credit-driven growth model is clearly falling apart,” said Chu in a recent report. Chu’s argument is that usually “stress starts in the periphery and moves to the core.” Here are five signs that she’s right:
1) Plummeting exports in May
A government crackdown on fake trade invoicing likely caused a sharp drop-off in exports, which rose 1% year-over-year in May, compared with 14.7% in April. (Export traders overstate export orders to take out cheap loans in Hong Kong, funneling those loans into shadow banking investment products, which offer higher returns.) That means export growth (and economic growth overall) has been much less than China’s headline data suggest.
2) The spike in interbank rates continues
Smaller banks are scrambling to get cash. Interbank rates began spiking in early June, when the export invoice crackdown officially began. The immediate cause was the alleged default on mid-tier Everbright Bank’s 6 billion yuan loan from Industrial Bank. The crackdown on invoicing probably worsened the resulting liquidity shortage. The one-week rate has come down only a little from early June.
3) A crackdown on unsecured loans is imminent
A scheme similar to fake trade invoicing is brewing in short-term bank notes. In Q1 2013, banks issued 670 billion yuan in short-term bank notes, up 198% from the same period in 2012. “Over the last couple of years is that banks will kind of invent assets out of thin air in order to create loans,” Anne Stevenson-Yang, founder of Beijing-based J Capital Research, explains. “The main one over the last few months is reverse [repurchasing agreements], which manage not to be booked against a bank’s loan-to-deposit ratio, so it’s kind of like free money.” If the government blocks this form of interbank trade, mid-tier and smaller banks will suffer even more.
4) Businesses are lying about profits and drowning in debt
The latest report from Caijing says that 71 firms in Guangdong exaggerated their earnings by more than $1 billion combined. And the problem extends beyond Guangdong. “It is an open secret that aside from state revenue, all the other economic data are jellyfish,” (link in Chinese) a Fujian township accounting worker told Yicai (the implication being that jellyfish are 90% water). As companies lean more on credit-fueled investment in real estate and infrastructure projects (link in Chinese), they are more likely to inflate earnings to mask their lack of genuine growth. And as we recently discussed, corporate debt could amount to as much as 220% of the GDP.
5) Local government financing platforms are desperate for loans
China’s businesses and local governments aren’t bringing in anywhere near enough cash to keep up with debt payments. As a result, local government-affiliated investment vehicles are willing to borrow at rates of 17.5-20% and they’re padding their balance sheets with fake collateral, based on a recent government survey. Obtaining those kinds of new loans to pay off the old ones will become nearly impossible if the crackdown on fake invoicing and short-term bank notes dries up all that excess liquidity.