From rural bank runs to surging consumer indebtedness and an unprecedented bond restructuring, mounting signs of financial stress in China are putting the nation’s policymakers to the test.
The Chinese government is facing an increasingly difficult balancing act as it tries to support the world’s second-largest economy without encouraging moral hazard and reckless spending.
While authorities have so far been reluctant to rescue troubled borrowers and ramp up stimulus, the costs of maintaining that stance are rising as defaults increase and China’s slowdown deepens.
Policymakers are attempting to do the “minimum necessary to keep the economy on the rails,” Goldman Sachs Group Inc chief Asia-Pacific economist Andrew Tilton said in a Bloomberg TV interview.
Among China’s most vexing challenges is the deteriorating health of smaller lenders and regional state-owned companies, whose financial linkages risk triggering a downward spiral without support from Beijing.
A landmark debt recast proposed this week by Tianjin-based Tewoo Group (天津物產), a state-owned commodities trader, has raised concerns about more financial turbulence in the city.
Concerns have popped up across the nation, often centered on smaller banks. Confidence in these institutions has waned since May, when regulators seized control of a lender in Inner Mongolia and imposed losses on some creditors. Authorities have since intervened to quell at least two bank runs and orchestrated bailouts for two other lenders.
In its annual Financial Stability Report released this week, the People’s Bank of China described 586 of the nation’s almost 4,400 lenders as “high risk,” slightly more than last year.
It also highlighted the dangers associated with rising consumer leverage, saying household debt as a percentage of disposable income jumped to 99.9 percent last year from 93.4 percent a year earlier.
The central bank and other regulators have long warned about the risks of excessive corporate debt, which climbed to a record 165 percent of GDP last year, Bloomberg Economics data showed.
For now, investors appear to be betting that policymakers can manage the nation’s financial risks and keep the economy afloat.
The Chinese government’s sale of US$6 billion of sovereign debt this week was oversubscribed, while volatility on stock markets has dropped to the lowest level since early last year, in part due to optimism over the prospects for a trade deal with the US.
Yield spreads on the short-term debt of lower-rated Chinese banks relative to their “AAA” peers have narrowed, a sign that smaller lenders are finding it easier to secure funding.
However, there are signs that investors are on edge.
A sudden tumble on the Hong Kong Stock Exchange yesterday spread to mainland markets, with the Hang Seng China Enterprise Index sinking as much as 2.6 percent amid nervousness over a lack of clear triggers for the slump.
The central bank and other regulators have said they are forcing troubled banks to increase capital, cut bad loans, limit dividends and replace management.
They have also floated a sweeping package of measures that would encourage mergers among smaller institutions and enlist local governments to support them.
The Financial Stability and Development Committee, chaired by Chinese Vice Premier Liu He (劉鶴), on Thursday called for more ways to beef up capital strength at smaller banks, and set up a long-term mechanism to prevent and resolve risks.
The nation’s top securities regulator said earlier this week that more efforts should be made to protect shareholders, especially retail investors, while actively guarding against liquidity and credit risks on capital markets.
In one sign that authorities could be growing more concerned about downside risks to the economy, the Chinese Ministry of Finance on Wednesday said that it had ordered local governments to speed up the issuance of debt earmarked for infrastructure projects.
The move put a fresh spotlight on the policy dilemma facing the nation’s leaders: While such support measures might help bolster economic and financial stability in the short term, the risk is that they lead to even bigger debt problems down the line.
Authorities have been trying “to bring discipline into the market, but every time that happens, the consequences become frightening, so they back away,” Peking University professor of finance Michael Pettis said. “The longer you take to solve it, the more distorted the market becomes and the more painful the resolution becomes.”
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