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Why the Future Fund fears for China
David Neal manages the $118 billion Future Fund, and here's why he's worried that China's transition from an infrastructure-driven economy to one carried more by consumers.
PT0M39S 620 349China may have $US1.3 trillion ($1.7 trillion) loans extended to borrowers that don't have sufficient income to cover interest payments, with potential losses equivalent to 7 per cent of the country's gross domestic product, according to the International Monetary Fund.
Loans "potentially at risk" would amount to 15.5 per cent of the country's total commercial lending, the IMF said in its latest Global Financial Stability Report. That compares with the 5.5 per cent problem loan ratio reported by China's banking regulator after including nonperforming and special-mention loans.
The true amount of bad debt sitting on the books of China's banks is at the centre of a debate about whether the country will continue as a locomotive of global growth, or sink into decades of stagnation like Japan after its credit bubble burst.
The true amount of bad debt sitting on the books of China's banks is at the centre of a debate about whether the country will continue as a locomotive of global growth. Photo: Bloomberg
Official data released on Friday showed China's economy grew at its slowest pace in seven years in the first quarter. But indicators from the country's consumer, investment and factory sectors pointed to nascent signs the slowdown in the world's second largest economy may be bottoming out.
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Gross domestic product (GDP) grew 6.7 per cent in the first quarter from the previous year, the data showed, in line with analyst forecasts and easing slightly from 6.8 per cent in the fourth quarter.
While it marks the weakest pace of expansion since the first quarter of 2009, other activity data reinforced previous signs that the economy may be finding traction with better-than-expected growth seen in retail sales, industrial output and fixed asset investment.
Soured loan risks
Hayman Capital Management's Kyle Bass in January flaggeda $US3.5 trillion potential loan loss for China banks, though analysts from China International Capital and Macquarie Securities have said that estimate overstates the real situation.
The IMF said loans potentially at risk aren't the same as nonperforming loans reported by banks and supervisors. Borrowers can sell assets to meet interest payments and banks can take steps to recover collateral and seize assets to avoid losses, it said.
Assuming a 60 per cent loss ratio, potential bank losses on such risky loans may amount to $US756 billion, the IMF estimated. That's manageable because the estimate is equivalent to 1.9 years of the banking system's estimated pretax profits for 2015, the IMF said, also noting that Chinese banks hold $1.7 trillion of Tier 1 capital.
Still, the organisation urged "prompt action" to address rising corporate sector vulnerabilities. Chinese firms are generating operating profits equivalent to only two times their interest expenses, down from almost six times in 2010, according to data compiled by Bloomberg.
Risks are concentrated in sectors such as real estate, manufacturing, retail and wholesale, mining and steel, the IMF said. Those industries have both high debt levels and a high proportion of loss-making firms, the organisation said. China's government has indicated it's drawing up plans to address high corporate leverage and nonperforming loans.
Encouraging signs
Despite the debt concerns, fresh activity indicators released Friday provided a more encouraging view on the economy.
Chinese banks extended 1,370 billion yuan ($274 billion) in net new yuan loans in March, exceeding analyst expectations and nearly double the previous month's lending of 726.6 billion yuan, suggesting renewed appetite for investment among wary Chinese corporates.
China's fixed-asset investment growth quickened to 10.7 per cent year-on-year in the Jan-March period, beating market expectations for 10.3 per cent, and industrial output growth leapt to 6.8 per cent, surprising analysts who expected it to rise 5.9 per cent.
Retail sales rose 10.5 per cent, slightly above forecasts of 10.4 per cent.
March export figures released earlier this week also staged an unexpected recovery, although some economists caution that seasonal effects from last year's late Lunar New Year holiday could be a factor.
Capital outflows, a major concern at the end of 2015, also appear to have eased in recent months along with the dollar's rise.
The tentative signs of recovery continue to face off against a wide range of risks present in both the domestic and global economies, with some economists warning it's just another unsustainable debt-fuelled uptick that might run out of gas.
"Today's released data ought not to distract from the fact that the structural issues facing China's economy remain unresolved," wrote Economist Intelligence Unit economist Tom Rafferty in a research note.
"It has taken considerable monetary and fiscal policy loosening to stabilise economic growth at this level and this effort has distracted from the reform agenda that is fundamental to long-term economic sustainability."
Bloomberg/Reuters