WHEN CHINA UNVEILED a $600 billion stimulus package in November 2008 it caught the world on the hop. Governments from Washington to Canberra eyed this largesse with longing, envious of Beijing’s ability to funnel vast amounts of cash into domestic industrial projects literally overnight.
For most of 2009 China was hailed as a steady hand on the wheel, steering the world through the worst of the global recession. But what few asked at the time was how Beijing was splashing the cash – and if anyone was overseeing the largest Keynesian fiscal package since the Great Depression.
A few simple but scary truths are now starting to emerge. First, the country’s leaders had neither hand on the wheel: they were driving blind and hoping no one would notice. Most of the $600 billion package – siphoned into the vast hinterland via leading state banks – wound up in the pockets of local authorities, most of which invested in pet projects designed to create short-term jobs, not long-term returns.
Such misdirected munificence will have two unintended consequences: crises lifted straight from China’s 1990s playbook. The first will be the virtual bankruptcy of dozens if not hundreds of heavily indebted municipal authorities. The second will be another banking bailout, mirroring those in 1998/99 and 2004/05, triggered by a resulting slew of new non-performing loans.
Beijing is only now coming to terms with this looming crisis. At the heart of the problem is the way the stimulus package was doled out. Fearful that slower growth would fuel social unrest, from early 2009 onward the central government authorized lenders such as Industrial and Commercial Bank of China (ICBC) and Bank of China (BOC) to flood the country’s 1,467 county-level authorities with bundles of cheap loans.
Most of that lending – around 75% of the entire stimulus package by most estimates ($450 billion) – was disbursed not to the authorities directly but to their wholly owned (and often listed) infrastructure investment vehicles, known as Udics (urban development investment corporations).
Those vehicles, suddenly flush with cash for the first time in more than a decade, in turn pumped money into projects that many had been itching to build for decades.
Some were vital additions to infrastructure, from rail projects in the south and east to apartments in the north and west. But too much was parcelled out to poorly conceived projects with little or no chance of generating a guaranteed return. Anyone who has travelled across China will have viewed with wonder the deserted five-star hotels in fifth-tier cities, or the brand-new "ghost towns", eerie and empty, that dot the landscape from Inner Mongolia in the north to Yunnan in the southwest.
In Credit Suisse’s 2010 Emerging Markets Quarterly, published on March 10, the bank’s chief regional economist for non-Japan Asia, Dong Tao, noted his alarm about the fiscal condition of local governments. "Last year saw a drastic surge in [local authority] indebtedness," he wrote, "caused by the government’s rush for infrastructure investments and aggressive bank lending."
Other analysts concur. Bill Stacey, a director at Hong Kong-based brokerage Aviate Global, and former chief Asia banking analyst at Credit Suisse, says: "Infrastructure lending to municipal platform companies was extraordinary in volume and is likely to create problems in the future."
What strikes fear into China’s leaders is how much of this lending will go sour. Opinions vary wildly. Craig Blomquist, the Guangzhou-based founder and chief executive of Fan Ya Tai, a mainland distressed debt specialist, believes that at least one-fifth of all bank loans disbursed over the past year will end up in default – and he adds that this is a "conservative estimate". He says: "The NPL build-up is going to be really bad." The amount that he estimates would generate at least $90 billion in new NPLs created by local Udics, most of which would have to be soaked up by leading banks, or one of China’s four leading asset management companies (AMCs), themselves still awash with failed loans from bailouts in the late 1990s and 2004/05.
And even this might be a low estimate. China’s leading banks disbursed a record Rmb9.7 trillion ($1.4 trillion) in new loans in 2009. A further Rmb7.6 trillion will flow out of the banks in 2010. Most has thus far ended up in the hands of local Udics and leading Chinese state-owned enterprises (SOEs) – another chunk of the Chinese economy suddenly flush with cash.
| IPO net first day increase: five most recent stock offerings |
| Company |
IPO price (Rmb) |
First day price (Rmb) |
% increase |
| Zhejiang Wanma Cable |
11.5 |
25.93 |
125 |
| Guilin Sanjin Pharmaceutical |
19.8 |
34.01 |
72 |
| Sichuan Expressway Company |
3.6 |
10.9 |
203 |
| China State Construction Engineering |
4.18 |
6.53 |
56 |
| Your-Mart Company |
19.58 |
37.9 |
94 |
| Source: Shanghai Stock Exchange | |
Worse, state banks have committed themselves to lending another Rmb12.7 trillion by the end of 2011 to local municipalities – the very authorities currently squandering their ill-gotten wealth on golf courses and empty shopping malls. If just one-fifth of those new loans go sour, China’s lenders will have a further $425 billion in NPLs on their books, pushing the total well beyond $500 billion.
Half a trillion dollars is more than one-eighth of China’s nominal 2009 GDP ($4.9 trillion) and roughly a fifth of China’s jealously guarded foreign reserves (currently running at $2.4 trillion). It’s also on a par with the roughly $600 billion to $700 billion in dud loans carved out of China’s three largest banks – BOC, ICBC and China Construction Bank (CCB) – in 2003 and 2004.
Other observers reckon that China’s municipal funding crisis is only just getting started, relating it to the sub-prime lending crisis that shook western nations to the core in 2008. The respected mainland newspaper Caixin said on February 5 that up to 70% of all loans parcelled out to Udics – or around $315 billion just from the basic stimulus package – could fail.
