On Friday Stephen Green of Standard Chartered delighted his fans in the market by putting out a piece called “We strike gold in the Q1 PBoC report” in which he highlights 14 “gold nuggets” he found hidden away in the PBoC report. There was a lot of interesting stuff in his report and I recommend that people who are interested ask Standard Chartered to send them a copy.
I want to highlight three of these “nuggets”.First, Green notes that the official GDP deflator rose substantially – from 5% year on year in the last two quarters of 2007 to 8.2% in the first quarter of 2008.There are a lot of problems with the GDP deflator figure, but Green argues that the fact that it jumped so sharply is more evidence that inflation has become a real problem and is spreading through the economy.Given how sharply it jumped he even wonders why there weren‘t big headlines about this.
Second, and this is most interesting to me, lending constraints on commercial banks have been applauded for having slowed the growth in lending by 14% in the first quarter of 2008, compared to the first quarter of 2007. But these lending constraints do not seem to apply to the policy banks, and their total lending surged by 86% compared to the first quarter of 2007.Since they comprise 12% of all new lending in Q1 2008, their impact on loan growth is far from negligible – including their loans, total new lending only declined by just under 8%.I can’t prove this, of course, but I suspect that if we were to include loans from the informal banking sector, loan growth might not have slowed at all in the first quarter.
Remember that one of the strongest tools available to the PBoC to fight domestic overheating and excess demand has been restrictions on loan growth. I was never very confident that these kinds of measures would work because I assumed that, given the country’s explosive monetary growth, lending constraints would simply push new investment off the banks’ balance sheets.Green’s “nugget” seems to suggest one way in which this is happening.
Third, and perhaps another way in which this is happening, Green notes that foreign currency lending by Chinese banks soared in the first quarter, from $2 billion in Q1 2007 to $48 billion in Q1 2008. The PBoC claims that 73% of this lending went to support foreign acquisitions by Chinese companies, but Green finds it hard to understand how this can be the case.He believes a lot of this lending may actually have been used for domestic lending, perhaps to get around RMB lending quotas, and if these were added to the total new RMB loans issued in the first quarter of 2008, including the surge in loans by policy banks, new lending would actually have grown, not declined – if you include loans by policy banks and foreign currency loans, total new lending was 15% higher in the first quarter of 2008 than over the same period last year (and this still ignores the possibility of expansion in the informal banking sector).
By the way another “nugget” Green discovers is that average lending rates at the Chinese commercial banks have gone up by only 20 bps from January to March, much less than inflation. I would argue that this is additional circumstantial evidence that the lending constraints are not biting, or else I would have expected corporations to bid up borrowing rates.I may be wrong here, because existing banking relationships might make it hard for banks to raise their lending rates too quickly, but it seems to me that if corporations were starving for access to loans one way of rationing this access might have been to raise lending rates.
Green also observes a big jump in FX swaps during the first quarter, and suggests this supports his view that a significant portion of foreign currency loans are being spent in China, not for foreign acquisitions.By the way this may explain some of the remarkable jump in foreign currency reserves at the PBoC during the first quarter.
Turning away from Stephen Green’s detective work, the PBoC Q1 report also noted that NPL’s declined from 6.2% at the end of 2007 to 5.8% at the end of the first quarter.Remember that the NPL ration can improve by a decrease in NPLs or by an increase in total loans. I don’t remember how much total loans increased during the first quarter (and I am going to the dentist in a few minutes because of a massive toothache that has made my weekend miserable, so I don’t have time to dig up the numbers), but I note that a 6.5% increase in loans would be enough fully to account for the decline in the NPL ratio.
Fascinating, problem is how do bankers track "informal loans"? As for the NPL, the problem is it's not a static % (not for the reasons cited) but rather the fact that as a banking crisis gains momentum (your last post), it may not be uncommon to see for example:Corporation A defaults, its suppliers (corp B ) may suffer liquidity problems, that leads to the possibility of corp C (B's suppliers) going the same way. That's the unfortunate consequence of a liquidity crisis, whichcould cause the NPL figure to explode dramatically.
Not to be overly annoying in my stupidity but what were those foreign currency loans spent on?
BTW, linked a post on my own blog to your last post, hope you don't mind!
The PBoC says taht a big part of the foreign exchange loans was used to support the "Going out" policy -- Chinese companies acquiring assets or companies abroad. Green is not comfortable with this explanation, although I spoke to Logan Wright last night and he said there has been a big boom in investment abroad, so the PBoC may be at least partly right. It seems that part of the loans were used to pay for imports -- although since in the past the importers used RMB loans, this represents effectively a form of hot money inflow.
By Michael Pettis - 5/19/2008 12:31 PM
Thank you, thought it would only be polite to ask/cite, a hangover from university days!
The part about using foreign excahange loans to pay for imports; as long as it's a small % , fine, the problem is, in times of currency volatility, it's tempting to use it as a free hedge, the flipside, as you pointed out is the hot money phenomena. In the long run, financing in another currency without preparedness to be able to produce it at short notice always leaves the borrower at the mercy of volatility and ultimately both the loan issuer and the creditors (who they were paying with foreign loans). How similar is this situation to Asian companies who financed via loans denominated in foreign currency, for example, Korean companies or Thai companies, pre 1997? This is not so much concern over a repeat of the Asian currency crisis as concern over lack of attention to treasury concerns.
That's just my financial paranoia in overdrive. If it's not to o rude to ask; any idea how to get a full copy of the Green report online?
Obviously Mr Hotmoney has not received Prof Pettis' prior post. When it is least expected, the damages tend to be most severe, but what can go wrong one might ask? China has $400b foreign debt against a reserve that is too much to count, and RMB is shielded from Soros-type raids, thus foreign liabilities are not likely to provide any excitement. One might then expect any financial/banking stress to be largely RMB denominated. China can draw from the US experience in inflating the debts away by creating even more debts in its own currency. In a comparatively monolithic banking system, "Hoarding of Money" will not be an issue as with the European and US banks. It will be champagne free flow, as usual. So where will the trouble start one might ask? How about some heavy doses of asset hyper-inflation and consumer ultra-inflation? That is not difficult to fix too. CPI are no longer a straight (and honest) measure cost of living increases. If we the common folks were to do what they did to calculate CPI around the world, we would be charged with fraud. ALL central bankers are warning the heightened risks of inflation but nobody is blinking. The party continues. Many, if not most, did not expect the China stockmarkets to drop so much, so fast. Technically, much of the downside risks have been taken out by this sharp correction, however, I cannot help comparing Shanghai Composite to SP500 after the tech bubble burst in 2000. It took 12 months to drop 30% from its peak, and then rebounded 22% over the next 2 months. There were, as always, loud talks then of the worst being over. The final low was not found until another 17 months later, after another 42% drop. From peak to trough, SP500 took 31 months to give back 51%. SHA Comp took just 6 months to give back 60%, and has since then rebounded some 26% in just 9 trading days. The earth is surely revolving faster these days. I believe Prof Pettis once wrote 'when things go wrong, they tend to go wrong all at once'. The surprise maybe how deep and long those things can stay 'wrong'.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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- 5/18/2008 5:21 PM
September, 2007