The tough road ahead for China

By | November 5, 2018

The peculiar state of Chinese economy

Spent a week in China. Spoke to many friends who work in different parts of the Chinese economy: some executives in private companies who are listed in “OTC market” (新三板)、some investment professionals in wealth management companies、some medical staff, some manager of a movie theater chain and various everyday folks in the country.

Almost everyone spoke to me (with exception of a retiree) starting with the phrase “the underlying economy is a lot worse than you read in the headlines

The #1 problem for companies? Bad debts.

According to people working in investment management or working in real businesses, there is huge amount of bad debt in a chain of companies: from upstream to midstream to downstream. Many companies (especially small and medium-sized businesses) are behind their repayment obligations or even debt service obligations.

Major banks are given orders by the government that as long as the debt is serviceable, they must extend the credit to the borrower without calling the loan balance (to avoid borrowers’ potential bankruptcy).

And the irony is that the receivables of these companies are against the same type of entities: provincial or local governments. So it created a vicious cycle: the local government “request” companies to provide goods or services for their political or social tasks, recording the receivables to the companies’ balance sheet. The cash strapped companies then struggle to pay back debt when it is due and the lender are forced by the government that instead of calling the loan at maturity, extending it with same term.

Because if you call the loan then, the struggling companies’ assets are not enough to pay back the debt due to pulling back of real estate values, and other asset prices from deleveraging process. You then can’t stay solvent.

This is almost a typical Japanese-style recession from the 80s, and the companies are called “zombie” companies. Nowadays there are a lot of such zombie businesses in China!

The banks are not calling back their old loans, which will limit their ability to growth credit to new businesses, naturally putting a regulator to growth of the economy. And in the event that even debt service is not met, Central bank is going to step in to provide support, by lowering the required equity ratio or other measures.

The net-net effect would be a gradual expansion of RMB supply, resulting to a weaker and weaker RMB in this process. 

And the #1 problem socially, is P2P lending.

Because of the issue above, banks are not in the market to provide loans to small and medium-sized businesses, these companies turn to the other channel: P2P lending. The banks will not lend money for even a higher interest rate and P2P however, will play the game.

As a result, P2P lending money to small businesses on one end, and raise money, promising “principal guaranteed’ opportunities to individuals on the other hand.

Due to lack of regulation in P2P space, lots of marketing terms are being pushed to everyday ordinary people as “principal guaranteed”, “return guaranteed” etc. They were marketed through lots of bank branches, however, sponsored by third party entities that are unaffiliated with these major banks. The way they are “pushed” to everyone are very liberal. The salesperson can say anything and everything. Sometimes I can’t believe what I am hearing: “Uncle, this is the product that will guaranteed to return you full money in 5 years, with at least 5% annual interest! Trust me, I just bought 1 million RMB of this!”

You almost see a horror movie slowly unveiled right in front of your eyes.

Within only 6 people I have spoken to, 1 was scammed 200K RMB by a so-called fund “investing” in some restaurants’ inventory… another 1 was scammed 10 million RMB and one of his partners who helped raised money committed suicide.

The P2P issue is a huge issue that can cause potential social unrest, in addition to disruptions to normal economy activities.

With the 2 issues above, and the on-going trade frictions, Chinese economy has the work cutout ahead in 2019. The large State-Owned enterprises are most safe now however if the consumers suffer heavily from their own P2P investments, if the small businesses stopped spending due to bad debt issues, can the SOEs really step up the plate and support the GDP to grow at 6.5% annual rate?

Leave a Reply