China Kicks the Debt Can Down the Road
The move by the Communist Party to force national banks to roll and extend local government’s debts reminds us that these banks serve at the pleasure of the ruling party, making them a policy arm of the government. We remain agnostic on the timing, but at some point the significant misallocation of capital that is occurring in China will have to be worked through. The size and scope of the debt indicate that a few years of growth may not be enough to solve the problem.
Central planning still does not work. Large systems are too complicated for individuals to run. Even the staggering advantages the Chinese enjoy including a comparative advantage in labor costs will not shield them indefinitely from the limitations of human nature.
China has instructed its banks to embark on a mammoth roll-over of loans to local governments, delaying the country’s reckoning with debts that have clouded its economic prospects. China’s stimulus response to the global financial crisis saddled its provinces and cities with Rmb10.7tn ($1.7tn) in debts — about a quarter of the country’s output — and more than half those loans are scheduled to come due over the next three years. Since the principal on many of the loans is not repayable, banks have started extending maturities for local governments to avoid a wave of defaults, bankers and analysts familiar with the matter told the Financial Times. One person briefed on the plan said in some cases the maturities would be extended by as much as four years.
Anticipating that maturity extensions might be allowed, Standard & Poor’s said last month that such “regulatory forbearance” would be expedient, forestalling a surge in non-performing loans. “But it’s also likely to undermine investors’ confidence for some time to come, underscore the developing nature of the regulatory framework and highlight the banking regulator’s lack of independence,” said S&P credit analyst Ryan Tsang.