Notes from Beijing
I just returned from a week in Beijing meeting my local contacts. Several interesting points emerged:
New Loan Limits Imposed by the Banks
State firms have been the favorite borrowers for most banks in China for the obvious reason that they are a reliable credit. That may be changing. According to bankers in Beijing, a series of defaults have exposed the banks to the weakness of state firms, particularly local state firms. There are 103 centrally, Beijing state firms, and more than 100,000 local state firms. Most recently, the National Salt Company, the monopoly provider, defaulted on loans to five banks. One bank was exposed to the Beijing branch of National Salt for 60 million renminbi. The defaults actually occurred on a letter of credit to the salt processor in Guangdong Province. “China Salt is a grain company. It’s more like a government agency. Maybe used the capital for other investments,” said an official at the NDRC.
Surprisingly, National Salt, with 45,000 employees, is controlled directly by Beijing. But this time around, Beijing hasn’t stepped in to bail out the company. In fact, usually the Beijing holding company would provide credit to an operating unit in trouble, but this hasn’t happened. Instead, the dispute is being fought in the courts.
As a result of this and several other defaults, state banks have begun imposing internal quotas on lending to state firms – the first time this has happened in recent memory. An official formerly with the China Banking Regulatory Commission (CBRC), told me that this quota system would not have been dictated by the CBRC but would have come from the banks themselves.
What does this mean? State banks supply roughly half of total loans. Roughly half of all loans are made to SOEs. (We’re omitting Shadow loans). A widespread quota on SOE loans would severely curtail their ability to operate effectively. We’ll see how widespread this becomes.
In addition, apart from the SOE quotas, a banker with a large Chinese bank in Beijing said they are now restricting lending to property developers outside of the city. They are concerned with the property downturn in smaller, tier 3-4 cities. This is in line with my expectation that credit increasingly will flow to what Chinese call Beishanguang – Beijing, Shanghai and Guangzhou, the most important, wealthiest and politically powerful cities.
Rise of Private Banks
Private, non-listed banks officially haven’t existed in China. There are state banks, shareholding banks (listed), and city banks. But privately owned regulated financial institutions (outside of the non-regulated shadow banks) have not been permitted. That is changing. In the past year, Beijing has allowed the creation of five private banks and is on the cusp of approving three more. The five have capital each of around 4 billion renminbi. The officials I spoke with are grappling with the problems of regulating a bank where the financial fiduciary is a private citizen, as opposed to a state entity, shareholders, or a number of corporations. The logic behind this is twofold: allow the expansion of private credit, and shift Shadow Banking credit flows into more normalized, transparent channels. I asked whether this was a threat to the existing state banks that are central to China’s economy. The answer was they are yet too small in market share to do much damage but they are the wave of the future.
Xi Jinping and Policy Confusion
There’s been a great deal of debate about the current state of China’s policymaking. Does China have an understanding of its debt, inefficient state industries, and slowing economy? The confusion among western analysts/investors reflects division within the leadership, particularly of Xi Jinping and Premier Li Keqiant. Xi and Li themselves have contrasting views of how to proceed. Li Keqianq views himself as a kind of a liberal reformer. He believes the state system should be reformed to eliminate inefficient industries. But in the meantime, he is in favor of continued stimulus to maintain growth. These clearly are contradictory goals.
In contrast, many here see Xi Jinping as genuinely concerned with the excesses of the state system. But his method of attack involves a rapid curtailment of excess capacity in older industries. This would reduce the waste of capital and — in his view — lead to the creation of “new economy” type firms. This is a more rapid and more abrupt reform of the economy than that envisaged by Li Keqiang and explains Xi’s increasingly hard-line political stance. Political tightening would be a bulwark against the likely protests due to closure of state firms caused by this abrupt reform. However, in the end, Xi would slim down the state sector, but maintain it in the hands of the Party. There would be little change in the underlying dynamic of Party control of the economy. In that sense, he is a classic leader in the Stalinist mode.
Problems with One Belt
I had several discussions regarding Xi Jinping’s much heralded program to invest in infrastructure in Asia under the “One Belt One Road” program. However, clearly the government aims are being thwarted. According to an official with the NDRC planning board in charge of the program, the goal is to provide jobs and business for state firms, along with improving trade flows in Southeast and Southwest Asia. The capital for key rail projects is coming from low-interest bank loans from the China Development Bank. Other projects that may be profitable are funded through commercial loans from Chinese banks. However, bankers I spoke to are increasingly leery about OBOR because they expect many of these loans to default. One banker said her bank, owned by the Beijing government, has specifically mandated a reduction in loans to the various state owned railway companies that are building many of these rail networks abroad. “We are reducing exposure to national rail due to exposure to western projects in places like Baluchistan,” the banker said. The OBOR theme is very much a policy driven investment and likely to be a significant headache for years to come.
Meanwhile, the government is pushing the banks to make loans and contribute a portion of aid in renminbi. This would help prop up the currency and facilitate purchase of Chinese equipment by removing currency risk for Chinese firms.