SinoInsight 1
On July 6, the Renmin University of China hosted the 2019 International Monetary Forum. In a keynote speech at the forum, Zhou Yueqiu, director of the Industrial Finance Institute of the Industrial and Commercial Bank of China, said that it is necessary to guard against major financial risks pertaining to local government debt.
Noteworthy points in Zhou’s speech include:
- China’s financial sector leverage ratio reach as high as 248 percent in the first quarter of 2019, while the non-financial sector leverage ratio rose higher than real economic growth. The rise in the real economic leverage ratio was the reason for the rise non-financial sector leverage ratio.
- State-owned enterprise debt comprises over 60 percent of the leverage in the non-financial sector. More than 50 percent of SOE debts are owed to government financing platforms.
- There are presently over 11,000 government financing platforms across China. Nearly 80 percent of these financing platforms are used by prefecture-level cities.
- The main purpose of government financial platforms is the financing of local government infrastructure projects and public utilities. These platforms are facing a centralized reimbursement problem.
- More than 70 percent of new investment bonds issued to urban local governments are being used to repay old debts. In 2014, only 7.7 percent of investment bonds went towards paying off old debts.
Chinese banks hold more than 90 percent of local government debt.
OUR TAKE
1. We warned several times about China’s severe local debt problems in 2018. In our China 2019 outlook, we predicted that “local debt defaults will increase.” Zhou Yueqiu’s speech confirms our analysis of China’s local debt woes and puts our prediction on track for verification.
2. We analyzed last year that China’s implicit debt could be between three to five times greater than its explicit debt (see here and here). According to official data, local government debt balance in 2018 was 18.07 trillion yuan, an increase of 1.6 trillion yuan from 2017. In 2019, the scale of new local government debt will reach a record 3.08 trillion yuan while the local debt balance will hit 22 trillion yuan.
If we take local government implicit debt to be four times greater than explicit debt, then China’s debt size could reach 88 trillion yuan in 2019. In calculating interest at 5 percent, local governments have to pay a total of at least 4.4 trillion yuan per annum in interest. Local governments will not be able to pay off the estimated interest given that over 70 percent of new investment bonds are being used to repay old debts; local governments must make profits of at least 17 percent on the remaining 30 percent of financing derived from new investment bonds to pay interest. China’s debt bubble will only grow bigger and bigger as local governments struggle to repay both interest and principal.
We believe that it is only a matter of time before China’s local debt problem blows up. And the Sino-U.S. trade war is one of several possible triggers.
3. Should China’s debt problems blow up on a large scale, its financial and economic system will be seriously impacted. Financial and economic problems will in turn greatly weaken the CCP’s political legitimacy sharply raise the probability of Black Swan events breaking out in China (see our China 2019 outlook).
SinoInsight 2
Recent frontpage articles on the Xinhua website reveal a new rhetorical line on “structural reform”:
July 6
Lead article headline: “The Party Central with Comrade Xi Jinping as the Core Promotes the Reform of Party and State Institutions”
Lead article photo: “Xi Jinping attends a meeting on deepening reforms of Party and State organizations and delivers an important speech on July 5.”
July 7
Lead article headline: “Don’t Forget History, Xi Jinping’s Words are Powerful and Resonating”
Lead article photo: “Xi Jinping attends a meeting on deepening reforms of Party and State organizations and delivers an important speech on July 5.”
Major article headlines (leftmost column in the website front page): “On the Key Issue of Reform, Xi Jinping Makes the Final Decision”; “Li Keqiang’s Q&A with Representatives at the Davos World Economic Forum.”
OUR TAKE
1. We believe that the new rhetorical line is Xi Jinping’s way of reasserting his political authority after the G20 meeting in Osaka. Xi needs to reassert his authority after facing strong pushback in May for the draft of the Sino-U.S. trade deal and to ram through his structural reforms.
We explained in the July 5 edition of this newsletter why Xi needs to “signal left to turn right” on structural reforms and other policies.
2. The subtle shifts in the wording used by Xi to refer to reform hint at the domestic pressure he faces and how confident he is in his political strength. For instance, Xi used the phrase “structural arrangements” instead of “structural reforms” in his keynote speech at the second Belt and Road Forum for International Cooperation on April 26. We explained in the April 29 edition of this newsletter that Xi’s choice of words was influenced by his need to “avoid alarming Party hardliners and giving his political rivals an opportunity to attack him.” It should be noted that Xi’s shift to “structural arrangements” came just before the Chinese regime’s May about-face in the trade talks.
After meeting President Trump at the G20, CCP propaganda again shifted back to “structural reforms” as opposed to “structural arrangements.” Official media outlets also described the upcoming deepening of Party and state institutional reforms as “systemic, holistic, and reconstructive.” The more forceful language used to describe reform is an indication of Xi’s resolve to make the changes required in the regime to be able to commit to a trade deal with America.
We wrote in our G20 Early Brief analysis: “An optimistic outcome of the Trump-Xi G20 meeting would see both sides agree to keep communication channels open and restart the trade talks. Trump could give Xi a short reprieve to solve his domestic politics and ensure successful trade negotiations. To that end, Trump could either add $300 billion in tariffs at a 10 percent rate or even suspend the tariffs until further notice.” We believe that Xi signaling a commitment to reform within a week after returning from Osaka verifies our analysis that he is being granted a “short reprieve to solve his domestic politics.” Whether or not Xi succeeds in pushing through reform is a separate question.
(Our post-G20 meeting analysis report is now available for order.)
3. Xi’s structural reform push will inevitably harm the interests of various factions and interest groups in the Chinese regime. As factional fighting escalates, we believe that Xi could carry out purges that “may touch current and retired members of the Politburo and its Standing Committee.”
