Not All Rosy

By HU YUE

Not All Rosy

By HU YUE

(Left)FINANCIAL PROSPERITY:The central bank report says China’s commercial banks including the Industrial and Commercial Bank of China made juicy profits in 2009

China maintains financial health, though risks loom large

On September 17, the People’s Bank of China, the central bank, released the2010 China Financial Stability Report, offering a glimpse of China’s fi nancial landscape.

Nearly two years after the breakout of the global fi nancial crisis, the Chinese economy is moving quickly out of its shadow. This resilience has laid solid groundwork for the fi nancial industry to pick up impetus, though challenges remain, said the report.

A major component of the financial industry—the banking sector—burst with vitality in 2009, with both pro fi tability and asset quality on the rise. But, after a signi fi cant lending surge last year, the capital adequacy ratio of the lenders experienced a slight drop.

In 2009, the 17 major commercial banks generated after-tax net pro fi ts of 492.6 billion yuan ($72.4 billion), surging 12.37 percent year on year. Their bad-loan ratio stood at 1.59 percent last year, compared with 2.41 percent in 2008.

The securities and insurance industries roared ahead as well, as markets scaled up and trading stayed buoyant.

But fi nancial security is far from guaranteed. The local governments raised a pile of debt through hidden fi nancing vehicles, igniting concerns over solvency. Another cause for caution is swelling overdue credit card debt as cardholders are falling behind their monthly obligations.

The country’s outstanding non-performing debt through personal credit cards was 7.8 billion yuan ($1.15 billion) at the end of 2009,an increase of 3.5 billion yuan ($515 million)from a year ago.

China also has a lot to do to curb lending to highly polluting and energy-guzzling industries and soothing the fi nancial dif fi culties of the agriculture sector and small businesses,said the report.

Meanwhile, the aftershocks of the fi nancial meltdown are rippling around the globe,requiring China set up fi rewalls against possible risks.

Global economies are putting brakes on their monetary stimulus at varied paces, destabilizing the world’s fi nancial health. The European sovereign debt crisis also cast an ominous shadow over prospects for global economic recovery. The challenge must be addressed by trimming government de fi cits in the euro zone, said the report.

Many developing economies have experienced a resurgence of capital inflow, due to better growth prospects and relatively low interest rates. But with this comes the risk of in fl ation and asset bubbles. More disturbing,though, is the possible abrupt withdrawal of capital, which has the potential to send developing economies into an abyss.

Consistent stimulus

While the Chinese economy is staging a swift rebound, a bright outlook is not fully assured. The foundation of domestic demand remains shaky and private investments have yet to become a signi fi cant driver of growth.

The central bank reaffirmed its commitment to its proactive fiscal policy and moderately loose monetary policy as an effort to keep growth engines in top gear.

Despite such a fi rm commitment, a debate is heating up about whether China should raise interest rates in response to proliferating in fl ationary jitters and the housing frenzy.

DEBT SCARE:The Xiangshan Port Bridge in Ningbo,Zhejiang Province is expected to complete construction by 2012

The consumer price index (CPI), an effective gauge of inflation, rose 3.5 percent year on year in August, hitting a 22-month record, said the National Bureau of Statistics.

Meanwhile, real estate bubbles currently in the making across the nation have stretched nerves of policy-makers. House prices in 70 large and medium-sized cities rose 9.3 percent in August year on year,despite a heavy government clampdown on the property market.

On the monetary front, the central bank has required commercial banks to slow their paces of lending, and has also raised the reserve requirement ratio three times this year,pinching the banks’ ability to lend.

Economists are divided over whether more aggressive tightening is already in the pipeline.

“China’s one-year deposit interest rate now stands at 2.25 percent, well below the current in fl ation level,” said Guo Tianyong,Director of the Research Institute of China’s Banking Industry of the Central University of Finance and Economics. “Such negative interest rate in real terms is hurting the wealth of the depositors, and the only solution is to hike the interest rate.”

With growth holding up, China now has an opportunity to take its foot off the economic accelerator, he said.

Cheng Siwei, a renowned economist and former Vice Chairman of the Standing Committee of the National People’s Congress, said it is just a matter of time before China further tightens the monetary policy.

But that is less likely to happen in the near future as an early interest rate hike ahead of Western countries would accelerate hot money in fl ow and stir up waves in domestic fi nancial waters, he said.

Zuo Xiaolei, chief economist at Beijingbased China Galaxy Securities Co. Ltd., said she believed there was no urgency to move on the interest rate. “The CPI was driven up by rising food prices and labor costs, and not excessive liquidity,” she said. “In fl ation pressure will recede in the rest of the year as the agriculture sector shakes off the impact of nationwide rainstorms.”

China will need to walk a fi ne line between maintaining growth and managing in fl ation expectations, said the central bank report. Efforts to fend off fi nancial risks and beef up the rebalancing toward healthier and more sustainable growth will also be enhanced.

Local debt concern

A grim spot on China’s financial landscape is the financing vehicles of local governments used to provide money for roads, subways and other infrastructure projects. These vehicles take out bank loans backed by assets—typically land—or are supported by implicit guarantees of local governments.

Attempting to breathe fresh life into a sluggish economy, Chinese banks lent a record 9.6 trillion yuan ($1.4 trillion) of new loans last year, a chunk of which went into the local fi nancing vehicles.

By the end of June 2010, commercial banks had extended an accumulated 7.66 trillion yuan ($1.14 billion) to these vehicles, said the China Banking Regulatory Commission (CBRC). Of this total, about 23 percent is faced with serious default risks due to a lack of quali fi ed borrowers or guarantees.

Due to reckless expansion and less information transparency, the vehicles were adding to uncertainties hanging over the fi nancial sector, said the central bank report.

If local government debt sours, banks will be saddled with a pile of bad loans, said Stephen Green, a senior economist at the Standard Chartered Bank in Shanghai.

Especially if the real estate market tumbles and land sales shrink, the local governments will take a heavy blow to their solvency, he said.

But Ba Shusong, a senior researcher at the Development Research Center of the State Council, downplayed the worries, and said the burden remained bearable. China’s debt-to-GDP ratio was estimated at around 48 percent in 2009, well below the 229 percent of Japan and the 78.7 percent of the euro zone, he said.

In addition, even if local governments become insolvent, debt sustainability is not a problem, he said. Central budget can afford to support them, as fi scal revenue of the Central Government reached 3.59 trillion yuan ($528 billion) in 2009, 1.1 times of that of local governments.

Still, policy-makers have placed stringent controls over the financing vehicles.The State Council in May prohibited local governments from making illegal guarantees for them. In August, the Ministry of Finance,the National Development and Reform Commission, the central bank and the CBRC jointly released a circular, ordering a ban on bank lending to vehicles without a stable source of repayment funds.

Beside this, it was necessary to strengthen standardization and management of fi nancing vehicles and reinforce supervision over commercial banks, said the central bank report.

It also suggested China should make efforts to meet demands of local governments for fi nancing, such as allowing them to issue municipal bonds.

The local governments now have to hand over a majority of their revenues to the Central Government. These sorts of financial constraints are believed to be reasons why they have turned to different fi nancing vehicles.

It would also help if China could securitize financing vehicles’ loans and diversify the risks, said the report.