With little fanfare, Chinese financial authorities are cleaning up bad loans that threaten financial stability. The government is looking for the banks to absorb bad debt losses on their balance sheets. For remaining bad debts, the government is using debt management tools to extract maximum value from distressed assets.
At a recent IMA China CFO Forum meeting, members learned that this slow and steady approach is not without serious risks. Banks remain woefully undercapitalised and exposed to external shocks. Whether declared officially or not, non-performing loans (NPLs) will fail to generate interest and banks might miss cash flow targets. Rural and city commercial banks remain the most vulnerable. Should trust in the system take a hit, there is a concern the financial system could falter.
A growing toolbox for China debt restructuring
Practically unnoticed in the press, the government has been experimenting with various ways to unload debt. Authorities have a thriving toolbox to manage the debt. Debt for equity swaps, an active distressed debt market, state firms selling off equity are some of these tools. Foreclosure auctions also are fetching higher prices for distressed debt as more transparent online platforms such as Taobao and JD take on the role of auctioneers. These platforms have increased market awareness of the auctions and precipitated a sharp ramp up in prices.
Some analysts tout the sales of state assets to the private sector as another way to tackle the thorny SOE debt problem. Although SOEs are debt-laden, they are rich in assets. But, privatisation in China is typically a tricky political proposition. When state assets have been unloaded with too much enthusiasm, the government backs off. Yet, in some areas, like Chongqing, mixed ownership has spurred growth significantly.
The government will save the day. Or will it?
The single most significant way the government keeps the economy afloat is by having the People’s Bank print money. Capital controls keep the money in China. Chinese financial authorities can manage inflation in ways that market economies cannot.
The government recognises the hazard of this approach. It is trying to reform the system and extricate itself as the overall guarantor of the system. A financial expert at the IMA Asia meeting argued that, ‘The government must dismantle this implicit guarantee if they want a financial system that serves the economy without resulting in a massive accumulation of risk.’
But the greatest risk would lie in dismantling the guarantee. Things could unravel in a moment of crisis should the People’s Bank not intervene in a timely manner in a way that the market expects.
Click on the ‘Deep Read’ button to read more about China’s Quiet Debt Clean Up.
To learn more about IMA Asia’s memberships, click here or contact us at service@imaasia.com. To read more details about China’s debt go to the website of MacroPolo, a program of the Paulson Institute.