06 September 2013 16:45 [Source: ICIS news]
By John Richardson
PERTH (ICIS)--“If something feels as if it is too good to be true, it often is,” said an Indian-based chemicals trader.
On frequent visits to Guangzhou, Shenzhen, Shanghai, Beijing and other cities in 2009-2010, shortly after China launched its giant economic stimulus package, his gut feeling was that something wasn’t quite right.
“It just didn’t seem logical that construction activity could continue at that pace, and that the rich could carry on spending money as if it was going out of fashion,” he said.
But some analysts instead argued that China’s method of government trumped the West. They said that the economic rescue package, introduced in late 2008 to stave-off the impact of the global financial crisis, proved their case.
How times have changed. The chemicals trader’s gut feeling was clearly on the money.
Charlene Chu, Senior Director in the Financial Institutions Group at Fitch Ratings, who is based in Beijing, was also warning as long as 2006 that China’s banking system carried risks, including poor corporate governance.
And in an interview with Goldman Sachs, published on 24 August, she detailed what has gone wrong in China since 2008.
She said that:
*People are so focused on the withdrawal of quantitative easing (QE) in the US that they have missed what has been, perhaps, the largest credit binge of all time. At the end of 2012, China’s credit-to-GDP ratio was 200% – 70 percentage points higher than in 2008.
If you look at what happened in the UK or the US from 2002 to 2007, or in Japan in the late 1980s or in South Korea prior to their crisis in the late 1990s, the increases in their ratios were all roughly 40 to 50 percentage points. From the end of 2008 until the end of 2013, China’s banking sector assets will have increased about $14,000bn. That’s the size of the entire US commercial banking sector.
*There is tremendous confidence in the ability and the willingness of the Chinese Communist Party to bail everyone out. But as the system gets bigger and bigger, there are more questions about how feasible that is.
On top of all of these financial system issues, China’s growth model is peaking out. A few years ago nominal GDP growth in China was in the mid-teens. In that type of environment, problems can easily get papered over.
It’s only when growth slows that the challenges really start to surface, which is happening right now, making China susceptible to a major financial crisis.
*But an advantage of the Chinese system is that a crisis is not pre-ordained because of the high level of domestic deposits resulting in low dependence on foreign exchange, and a closed capital account.
Close links between state-owned banks and state-owned enterprises mean that there is a lot of tolerance for bad debt. But, as highlighted above, the flip side of this advantage is that imbalances can go on for far too long.
*The shadow-banking system is a huge ‘black box’. Nobody knows the extent of bad debt within this system because of the proliferation of small-scale lenders outside government control.
*This informal lending sector is undermining the health of the big state-owned banks, as their wealth-management products are part of the shadow-banking system.
A crucial meeting of China’s senior politicians takes place in November.
Policy initiatives announced during the meeting will indicate how China intends to avoid a major financial crisis.
“The November plenum is likely to represent a turning point for China,” said a Perth-based resources analyst.
“Investment-led growth is largely over, which has major implications for demand growth for all sorts of commodities. Instead, the focus is going to be on greater domestic consumption. During this transition process, a sharp slowdown in GDP growth seems inevitable.”
Broadly speaking, two scenarios seem possible after the November meeting. They are:
*China’s leaders introduce rapid reforms. This results in very few new approvals of, or financing for, construction projects, with even existing projects struggling to obtain the money necessary for completion. Meanwhile, large amounts of industrial capacity are shut down, including in the chemicals industry.
*A “middle way” is adopted. Projects already underway are completed, leading to a gradual tapering-off in chemicals demand. Meanwhile, industrial restructuring, thanks to the generous continued support of state-owned banks, is equally gradual.
A third option is that no major changes take place.
But most economists think that this cannot happen because imbalances would continue to build to the point where China would confront an even bigger crisis.
Chemicals companies, as they prepare their 2014 budgets, must, therefore, try to figure out exactly when chemicals demand will be adversely affected by the slowdown in investment.
Estimates must also be drawn-up of how severe the reduction in demand growth will be.
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