Goldman Reports $ 8.2 Trillion Worse Threat Than Evergrande China
The real worry about the drama of the China Evergrande default is the inevitable paranoia where there is smoke and fire that accompanies debt stumbles.
The most disturbing of these fires, according to Goldman Sachs analysts, is the surge in local government debt levels that President Xi Jinping’s men have done their best to hide. Default problems in the world’s most indebted real estate development appear to be small embers compared to the $ 8.2 trillion in local government funding vehicles underway.
And these are only the LGFVs that we know of. The data Goldman’s Maggie Wei highlights is from late 2020. Obviously, the tally is higher now, maybe significantly. Ten months ago, these hidden investment programs had reached 53 trillion yuan, compared to 16 trillion yuan, or $ 2.47 trillion, in 2013. They now represent about 52% of the gross domestic product of China, exceeding the official amount of outstanding public debt.
In other words, as frightening as the $ 300 billion Evergrande story may be, Xi’s government has far more serious problems. Most acute: to prevent GDP this year from falling too below the 6% that Beijing hoped to produce without exacerbating the country’s bubble problems.
The forces behind local governments sitting on vehicle debt financing worth twice Germany’s GDP date back to 2008. Even before the Lehman Brothers crisis, the dynamics of the Communist Party encouraged frenzy of government. municipal loans. The way local officials gained attention in Beijing – and achieved national notoriety – produced above-average GDP rates.
This prompted some twenty prefecture heads to engage in a sort of arms race for infrastructure. Metropolises have rushed to build skyscrapers, six-lane highways, international airports and hotels, white elephant stadiums, sprawling shopping districts and amusement parks and maybe even bid for a Guggenheim museum. Traveling through the Chinese hinterland, we often hear of imitating the “Bilbao effect”.
After the subprime crisis, this strategy shifted into high gear. Local governments were a key driver used by President Hu Jintao to avert the worst of the global financial crisis. The same with Xi’s men when the Covid-19 crisis arrived in early 2020.
The problem with the LGFV boom in China is the opacity that accompanies it. Despite all their talk about giving market forces a “decisive” role since 2012, Chinese leaders have made the country less transparent. The credit rating system has also failed to keep pace with the growth of Chinese capital markets.
Nowadays, international investment banks and news agencies fear that Chinese local governments’ debt bubble warnings could expose them to retaliation. Not very good for Asia’s biggest economy as it sets the welcome mat for BlackRock, JPMorgan, UBS and others rushing in.
Local government borrowing programs tackle another smoke-and-fire issue: China’s huge shadow banking universe. To be sure, the Chinese government, as part of efforts to curb shadow banking, has targeted more than $ 1 trillion in opaque products marketed as low risk and high return. Too often, these so-called cash management products have funneled money to riskier borrowers such as developers.
In June, the People’s Bank of China and the China Banking and Insurance Regulatory Commission banned these products from purchasing bonds rated below “AA”.
Yet, as Fitch Ratings analyst Janet Liu observes in a July 12 report, “Cash-based wealth management products have been an important source of funding for weak LGFVs that are struggling to secure bank loans. . We expect the change to reduce systematic risk in the long run, but reducing financing options for weak LGFVs will further weaken their financial flexibility. “
This loss of flexibility could create short-term control problems. It also serves as a microcosm of nested risks that fester beneath the surface of an economy that Xi is making increasingly opaque. No wonder the struggles of developers like Evergrande piss off global markets.
No wonder some of the world’s biggest investors are abandoning yuan-denominated assets, either. For every Ray Dalio, Founder of Bridgewater Associates, singing the praises of China Inc., there is a warning from George Soros about the “tragic mistake” made by those who rush to the mainland markets. Somewhere in between, people like Cathie Bois, the CEO of Ark Invest is struggling to determine whether China’s technological crackdown is a reason to “buy” or “sell” yuan assets.
These include the Government of Japan’s $ 1.75 trillion pension investment fund, the world’s largest. He now says he won’t even include China’s yuan-denominated sovereign debt in his portfolio. The timing is bad for China: FTSE Russell is about to start adding Chinese debt to its benchmark global bond index.
In July, GPIF Chairman Masataka Miyazono said the investment whale should be careful when investing in Chinese debt. And now Xi’s China is getting Miyazono’s answer. The bigger question, of course, is how the chaos of Evergrande collides with excessive local government debt as Xi pulls the rug out of China’s tech sector.
If you smell the smoke from the greater China area, you have a very wealthy company.