On building debt - Pettis

Little by little the claim repeated by so many China bulls – that you can never spend too much on infrastructure – is being eroded. It is possible, it turns out, to waste a lot of money even on infrastructure, and if debt-fueled investment is being wasted in China, as I have been arguing for over half a decade, then without doubt debt must be rising at an unsustainable pace. Last week Bloomberg had this article, which suggests that even the official numbers, which show debt soaring, may be understating the reality:

Debt accumulated by companies financing local governments such as Tianjin…is rising, a survey of Chinese-language bond prospectuses issued this year indicates. It also suggests the total owed by all such entities likely dwarfs the count by China’s national auditor and figures disclosed by banks.  Bloomberg News tallied the debt disclosed by all 231 local government financing companies that sold bonds, notes or commercial paper through Dec. 10 this year. The total amounted to 3.96 trillion yuan ($622 billion), mostly in bank loans, more than the current size of the European bailout fund.

There are 6,576 of such entities across China, according to a June count by the National Audit Office, which put their total debt at 4.97 trillion yuan. That means the 231 borrowers studied by Bloomberg have alone amassed more than three-quarters of the overall debt.

The fact so few of the companies have accumulated that much debt suggests a bigger problem, says Fraser Howie, the Singapore-based managing director of CLSA Asia-Pacific Markets who has written two books on China’s financial system. “You should be more worried than you think,” he said of Bloomberg’s findings. “Certainly more worried than the banks will tell you.

Why debt matters

There is more to the article.  For example Huang Jifa, in the investment banking division at ICBC, reportedly says that local government loans aren’t a problem because the projects will generate returns, even if not immediately. “The money that Chinese local governments have borrowed is not like the money people borrowed in Europe or Greece,” Huang said in a Nov. 24 interview. “The Chinese government’s borrowed money is all invested. Many projects will have returns.”

Maybe, but I am pretty skeptical.  The problem of course is that it doesn’t matter that many infrastructure projects in China have returns.  I am sure many do (as did many projects in Greece, no doubt).  What really matters is whether all the various projects in the aggregate are generating greater returns than the debt servicing cost, adjusting of course for all hidden and explicit subsidies.  If not, then debt levels must be rising faster than the economy’s ability to service the debt.

via www.creditwritedowns.com