Fwd: Between the red lines in China by rajesh kumar in MINT good read.

---------- Forwarded message ----------
From: sanjeev nayyar <sanjeevnayyar108@gmail.com>
Date: Thu, Jul 11, 2013 at 9:38 AM
Subject: Between the red lines in China by rajesh kumar in MINT good read.
To: esams Nayyar <esamskriti@suryaconsulting.net>

"Developments in China are immensely important for India. A sharp slowdown, or the so-called hard landing, in China will affect sentiments and attractiveness of the emerging markets in the developed world, leading to lower capital flow. However, India can take this opportunity, though it looks extremely difficult at this stage, to distinguish and position itself as an alternate investment destination in the region. A lower growth trajectory in China will also mean softer global commodity prices, which will help India as a net importer. However, the biggest risk could be on the strategic front. Military conflicts are a way of deflecting attention from internal problems. And China is increasingly getting assertive in the region."

 

Between the red lines in China by rajesh kumar in MINT 11/7/13

http://www.livemint.com/Money/v6Ibl0vepp034NI5JTCZWN/Between-the-red-lines-in-China.html

 

Something big is happening in China or, maybe, the world is once again reading too much into every bit of development in the fastest growing large economy in the world. Whatever be the case, undoubtedly, the well-being of the Chinese economy is more important to the world today than any time in the modern history. A slight shift in expectations can upset numerous calculations around the world. Developments in China are important for India both for economic and strategic reasons.

 

In June, interbank rates in China suddenly spiked. In a normal market economy, such rise in interbank rates, as it happened in 2008, would mean that banks do not trust each other and are not willing to lend. However, China is not a normal market economy and is heavily controlled by the state. And now we know that it was not the banks that doubted each other, but it was the People's Bank of China (PBoC), the Chinese central bank, which then refused to lend liquidity support to the banking system, presumably, to restrict excess lending. Credit conditions in the interbank market have eased, normalcy has returned and the sky has not fallen. Still the problem in the credit market and the reluctance of PBoC to lend liquidity support to the banking system underscores deeper fault lines in the Chinese economy.

 

Earlier in April, Fitch Ratings downgraded its long-term local currency ratings. The total credit in the economy has increased from the level of 125% of the gross domestic product (GDP) in 2009 to 198% of the GDP in 2012. The rise of shadow banking is also a big concern for the Chinese policymakers. Shadow banking is bank-like activity outside the banking system and is largely unregulated. But shadow banking is just one part of the problem. The bigger issue is that China, perhaps, is reaching the limits of its growth model, supported by massive fixed investment, state-controlled banks, state-controlled companies and a rigged exchange rate. Recently, William Pesek, a Bloomberg columnist, rightly described the state of Chinese economy as: "Over the past decade, China's economy has grown addicted to excessive credit growth, with state-owned banks encouraged to finance as many new skyscrapers, highways, airports, dams and ghost towns as needed to pump up gross domestic product."

 

In order to save the Chinese economy from the impact of the global economic slowdown and collapse in exports in the aftermath of the financial crisis, the state once again pushed for an investment-led growth. As a consequence, capital was consumed by unviable projects—roads to nowhere—and banks and financial institutions are left with stressed balance sheets. Excessive investment was also made in the real estate sector and, as stories of ghost cities are doing the rounds in the international media, the administration is trying hard to deflate the bubble. The Chinese administration, including its central bank, will now have to control the flow of credit before it gets completely out of control. But this could significantly slow down the largest economy in Asia. Slower growth in the given set-up could possibly lead to social and political tension in the most populous country in the world.

 

What is interesting to note is that problems of excess debt and issues in and around the banking system has not come up in China for the first time. The debt-fuelled growth in the 1980s and early 1990s resulted in very high levels of non-performing assets (NPAs) in the banking system. In an interesting book, Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise (2011), Carl E. Walter and Fraser J.T. Howie, both having worked extensively in China, note that in early 2000s nearly $480 billion worth of bad loans was spun off from the four largest banks in the country. Interestingly, these bad loans were transferred to the books of asset management companies (AMCs) created to handle such assets. Later, the same banks subscribed to bonds of these AMCs, effectively bringing back the same NPAs to its books through a different route. The recovery rate for AMCs is said to be about 20%. Differently put, a large part of the excesses built in the 1980s and 1990s is still floating in some form or the other in the Chinese financial system. And more got added after 2008-09. Therefore, at some point, the government will have to write off bad assets, recapitalize banks and rescue the financial system. But that will not be easy even for the Chinese state with all its might. Loans were largely given to state-owned companies and local administrations in various part, and writing off assets, among other things, would imply that state-owned companies have defaulted, effectively meaning a default by the state.

 

Further, China is in the process of rebalancing its economy from exports to domestic consumption. This will naturally reduce the pace of expansion and worsen the problem in the financial sector. Chinese stocks are already at a multi-year low. Clearly, if the situation is not handled carefully, China could be headed for a hard landing.

 

End note: Developments in China are immensely important for India. A sharp slowdown, or the so-called hard landing, in China will affect sentiments and attractiveness of the emerging markets in the developed world, leading to lower capital flow. However, India can take this opportunity, though it looks extremely difficult at this stage, to distinguish and position itself as an alternate investment destination in the region. A lower growth trajectory in China will also mean softer global commodity prices, which will help India as a net importer. However, the biggest risk could be on the strategic front. Military conflicts are a way of deflecting attention from internal problems. And China is increasingly getting assertive in the region

 

Warm Regards
sanjeev nayyar
https://twitter.com/sanjeev1927
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