In the first of a series of blog posts on the major challenges facing China's economy over the next 12-18 months, we look at bad debts.
High stakes in Hangzhou. Source of picture: Wikimedia
By John Richardson
A fascinating blog post by Patrick Chovanec makes this very worrying observation about China's bad debt problem:
"The web of interlocking, often incestuous, and sometimes circular credit arrangements is reminiscent of Wall Street in the lead-up to the subprime crisis, in which a relatively small amount of mortgage losses, which most people believed could be contained, triggered a chain reaction that brought down major banks and froze credit across the entire global economy."
He is referring to "credit guarantee companies" that are in danger of collapsing as a result of the slowdown in the real-estate sector.
Chovanec's analysis focuses on a "mini financial meltdown" in the city of Hangzhou where 62 companies, from furniture makers to import-export traders, have been affected by the collapse of the property developer, Tianyu Construction Co.
He makes the point that these circular credit arrangements extend well beyond Hangzhou to many other cities and towns.
And he adds that even if everyone in Hangzhou is eventually bailed out by the amply-funded central government, companies with almost no access to working capital or investment funds will no longer be contributing to GDP growth.
"Bailouts, when they do happen, don't make losses go away, they just impose them on someone else - the drag on growth remains," he writes.
This could well apply to many of the small and medium-sized enterprises which make up most of China's chemicals and polymers buyers.
"For the past several years, higher property prices led to more lending, which led to even higher property prices (and more and now less chemicals demand) and onwards and upwards," he adds.
"Now that the market has turned, lower property prices are undermining the basis for both past and future lending, and shutting down China's engine of investment-led growth."
Premier Wen Jiabao reiterated over the weekend that China must "unswervingly" continue to implement property controls to stop prices from rebounding. He is also in favour of changes to real estate taxes and wants to set up a long-term policy to control the property market, said the official Xinhua news agency.
"Tianyu was one of a handful of relatively small real estate developers that were allowed to go bankrupt recently, presumably because they weren't seen as worth rescuing," continues Chovanec.
"Yet allowing even that small thread to be pulled unraveled a whole web of credit relationships that put numerous banks and businesses in danger. Now think what could happen if a developer like Evergrande (one of China's ten largest, which was recently accused of hiding the fact that it is actually insolvent via massive accounting fraud) went bust."
One can take comfort in official data that suggests that China's bad debt problem is containable.
But can you trust the data?
Even the accuracy of electricity statistics, widely viewed as one of the few reliable measures of economic growth in China, is being questioned by HSBC and Standard Chartered.
And as Chovanec points out, just as was the case with sub-prime in the US, it is not just the data that counts, but also the hidden interconnections.