China debt burden threatens Minsky moment
* Overnight repo rate reaches 12% after interbank default
* Liquidity squeeze comes as debt reaches record levels
* Analysts say tipping point could be near
By Gareth Gore and Carrie Hong
June 7 (IFR) - A liquidity squeeze in China's interbank market in the past couple of days has added to warnings that the country may be heading for a devastating credit crisis.
Money-market rates soared on Thursday and Friday as banks struggled to access short-term funding, with traders reporting a chain of defaults in the repo market.
The seven-day repo benchmark spiked as high as 12% on Friday morning as banks scrambled for cash ahead of this week's Dragon Boat Festival holidays, before easing to 6.68%, still a 17-month high, after the central bank stepped in to restore order. The overnight repo benchmark hit a high of 15% on Friday, a 16-month high.
US and European traders watch interbank markets closely for early signs of stress, recalling that money-market rates spiked in the 2007 subprime crisis and helped tip Lehman Brothers into bankruptcy a year later.
Many traders dismissed the liquidity squeeze as a temporary blip, pointing to a similar episode ahead of the Spring Festival holidays in 2011. However, market talk that a number of mid-sized lenders had failed to honour repo redemptions also underlined fears for China's fast-growing debt burden.
Societe Generale has warned that China may face a seizing up of credit markets and subsequent collapse in asset prices in the next three years, with companies and local governments increasingly struggling to pay spiralling levels of debt.
Wei Yao, the firm's China economist, says the country is fast approaching a so-called Minsky moment, when cash-flow problems derived from excessive debt lead to mass defaults, the calling of outstanding loans, and a subsequent spiral of selling as debtors seek to liquidate assets to meet calls.
"A non-negligible share of the corporate sector and local government financial vehicles are struggling to cover their financial expenses," she said. "Debt servicing costs have significantly exceeded underlying economic growth. The debt snowball is getting bigger and bigger, without contributing to real activity."
China's domestic debt market has ballooned in recent years, and the country's bond market has yet to register a single default. Growth in loans has exceeded underlying nominal economic expansion in every quarter, but one, since 2009.
With national income lagging total credit, the relative cost of servicing debts has spiralled, creating an increasing burden on the world's second-biggest economy.
The French bank estimates that the total debt service cost - interest plus scheduled principal payments - is now equivalent to 39% of GDP, well in excess of levels of between 20% and 25% that prompted banking crises in the West in past decades.
Interest costs alone were equivalent to 9.2% of GDP, it said. "The debt snowball is getting bigger and bigger, without contributing to real activity."
Growth in bank loans exploded in 2009, topping 34% at one stage, as Beijing pushed banks to lend to avert a wider slowdown. Although it has since tailed off to 14.9% in the first quarter, the gap between loan growth and nominal economic expansion has widened in recent quarters.
The recent spike in Chinese yields, which have widened in line with other emerging-market debt amid the sell-off in US Treasuries, could push debt service costs higher as companies refinance. Retailer Golden Eagle, for instance, has seen yields on its 10-year bond widen over 90bp to 5.6% in the last month.
Brian Coulton, EM strategist at Legal & General Investment Management, believes China is unlike many other countries in that its high savings rate makes it less reliant on foreign flow. "A key starting point in examining China's debt problem is to recognise that it is self contained," he said.
"However. this doesn't mean that rising debt can be ignored. High debt in individual sectors raises the vulnerability of the economy to interest rate and other shocks, and increases financial stability risks."
Coulton estimates that debt in the real economy is about 190% of GDP.
Bankers say many firms are choosing to roll over their debts, meaning that the debt service ratio is likely below that calculated by SG because less principal is being paid than expected. Still, that process may only defer an eventual reckoning if growth does not catch up.
Such rolling-over has pushed many debtors into the shadow banking system because traditional banks no longer have the capacity - or appetite - to extend credit.
"The mechanism that still holds the situation together is the state-backed formal banking system and its unspoken commitment to support local governments," said Yao. "This precarious equilibrium could last a bit longer, but not much longer, particularly if the central government does nothing." (Reporting By Gareth Gore and Carrie Hong; editing by Matthew Davies and Steve Garton)
- Housing, jobs data weaken, but overall economic picture still upbeat
- Target cyber breach hits 40 million payment cards at holiday peak |
- 'Duck Dynasty' anti-gay fallout sparks debate on religion, tolerance
- UPDATE 3-Saab wins Brazil jet deal after NSA spying sours Boeing bid
- Zuckerberg to sell Facebook shares worth about $2.3 billion |