|China's capital conundrum|
Jan 26, 2010 Karen Maley businessspectator.com.au
Few banking systems have seen the explosion in lending that the big Chinese banks have recently experienced, as part of Beijing’s move to stimulate the economy.
This has had two main effects. In the first place, as my colleague Robert Gottliebsen recently wrote, it has prompted Chinese authorities to curb bank lending. Any banker will tell you that if you expand your lending too fast, you’re bound to end up with a lot of dud loans on your books.
Since then, we’ve seen the first signs that the big Chinese banks will be looking to bolster their capital reserves with massive equity issues.
The Bank of China – which has been the most aggressive lender in recent times – has unveiled plans to raise up to $US30 billion by issuing new shares.
Its move looks likely to be copied by its main rivals such as the Industrial and Commercial Bank of China and China Construction Bank. But this is not the first time the Chinese banks have raised huge amounts of new capital.
Seven years ago, the Chinese government was forced to inject $45 billion of capital the Bank of China and the China Construction Bank to cover their staggering levels of non-performing loans.
This time around the banks are looking to private investors to bolster their capital reserves with the big question being, how much of this new capital will be used to underpin fresh lending, and how much will be needed to help the banks cover mounting bad debts, particularly in the property sector?
Concerns over bubble-like conditions in Chinese property market have been steadily mounting. Global real estate broker CBRichard Ellis sounded a note of caution in a recent note on the Chinese real estate outlook, warning that office rents in many cities are slackening due to overcapacity.
In a recent article in the Chinese publication Caijing, Andy Xie the former Morgan Stanley chief Asian economist, gives an excellent analysis of why the Chinese property bubble must inevitably burst.
Xie argues that Chinese property is a politically driven bubble, resulting from the desire of Chinese policy makers to continue to achieve impressive rates of economic growth (see also INTERVIEW: China's stimulus leakage, October 15, 2009).
For a long time, China was able to notch up high growth rates because it was a low-cost producer, and because the world economy was buoyant. China grew its share of global trade, and was able to attract a huge share of direct foreign investment, but this strategy has stopped working.
China is no longer the lowest of the low-cost producers. Tepid growth in the United States and Europe means there is less demand for Chinese products.
As a result, China has turned to property to maintain its impressive record of economic growth, and a huge share of the country’s capital is now flowing into property.
As Xie notes, the problem with property is that it is an unproductive asset. In the short-term it allows the country to increase its economic output, but longer-term it does nothing to boost productivity.
Local Chinese governments face political pressures to encourage investment in property because their own performance is measured by how successful they are in fostering economic growth and collecting budget revenue. Property development allows them to score highly on both counts.
Xie notes that such a huge reliance on property actually inhibits China from achieving a more balanced economic growth. China’s rapid economic growth has created millions of white-collar workers such as managers, engineers, accountants and bankers.
These people should have middle class income for buying property, cars and taking vacations. But instead property prices have increased faster than middle class incomes, leaving China’s nascent middle class saddled with high property costs.
However, Xie predicts that this property bubble will soon burst – either due to oversupply (which caused the collapse of the US housing bubble), or rising interest (which burst the Hong Kong property bubble).
In the meantime, the big Chinese banks are under pressure to increase their capital buffers. And nervous investors will be hoping that tens of billions of dollars that Chinese banks raise will be ear-marked for lending, and not for covering massive write-offs of bad property loans.
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