SinoInsight 1
Nov. 21
The PRC State Council Financial Stability and Development Committee held a meeting to “study and regulate” bond market development and discuss measures to safeguard bond market stability. The meeting said that the recent increase in bond defaults is the result of “cyclical, institutional, and behavioral factors” piling up. The meeting also stressed that a “zero-tolerance approach” would be adopted, and all kinds of “debt evasion” will be severely punished to protect investors. Further, “fraudulent issuance, disclosure of false information, malicious transfer of assets and misappropriation of funds” will be investigated by the authorities.
Nov. 23
The China Banking and Insurance Regulatory Commission agreed in principle for Baoshang Bank to proceed with bankruptcy proceedings. The People’s Bank of China had announced this August that the bank would file for bankruptcy.
On the same day, the Beijing First Intermediate People’s Court announced that it had accepted Baoshang’s bankruptcy and liquidation case. According to a civil ruling issued by the court, the bank proceeded with its bankruptcy filing on Nov. 17 on grounds that it had insufficient assets and could not pay off due debts. An audit of Baoshang Bank included in court documents showed that as of Oct. 31, 2020, the bank held 446.5 million yuan (about $67.735 million) in total assets, 205.9624 billion yuan in total liabilities, and negative 205.5159 billion yuan in total shareholders’ equity.
In mid-November, Baoshang Bank announced plans to write off a 6.5 billion yuan tier-2 bond and not pay the remaining 585.6 million yuan of interest on the note. This was the first instance of a tier-2 bond in China being written off.
Based in Inner Mongolia, Baoshang Bank was taken over by the PRC authorities on May 24, 2019 after it was deemed to pose severe credit risks. Government restructuring saw parts of Baoshang’s good assets handed over to Mengshang Bank and Hong Kong-listed Huishang Bank, including four subsidiary banks outside Inner Mongolia. Post-restructuring, Baoshang became a local-only bank.
According to a recent article published in the state-run China Finance magazine, Baoshang Bank’s major shareholder Tomorrow Group had been “emptying” (掏空) the former starting in 2005 through various improper transactions, capital guarantees, and capital appropriation. Between 2005 to 2019, Tomorrow Group siphoned off 156 billion yuan from Baoshang Bank through 347 loans made by 209 shell companies. The loans eventually became non-performing loans, and Tomorrow Group owed annual interest of tens of billions to Baoshang that were never paid.
Bank bankruptcies are a rarity in the PRC. However, risks in the banking sector have been increasing unabated this year. In the first half of 2020, at least two rural banks, the Shaanxi Yulin Yuyang Rural Commercial Bank and the Hengshang Rural Commercial Bank, underwent reorganization.
OUR TAKE
1. Baoshang Bank’s bankruptcy affirms the predictions we made in the 2019 and 2020 editions of our China annual outlook. We wrote that financial institutions in China will go bankrupt, but “both central and local governments will not be able to bail out those institutions in most cases.”
2. Baoshang’s 6.5 billion yuan tier-2 bond write off could have a negative ripple effect in China’s financial sector, particularly among small- and medium-sized banks.
Since 2011, small- and medium-sized banks in China have relied on regulatory arbitrage to generate profits. However, many of these banks found themselves in hard times after the CCP cracked down on regulatory arbitrage in 2017 by introducing a slew of “deleveraging” policies aimed at curbing financial risks. As we wrote in the Sept. 21 edition of this newsletter, “China’s 4,005 small- and medium-sized banks make up 25 percent of the entire banking sector and hold nearly 80 trillion yuan of assets in total. Of the 4,005 banks, 605 have capital adequacy ratios below the minimum standard of 10.5 percent, while 532 of the 605 banks are at even higher risk levels.” Baoshang Bank’s failure to pay back the holders of its tier-2 bond could trigger serious financial risks for some small- and medium-sized banks, which would in turn lead to a larger crisis for China’s entire financial sector.
Compounding the problems faced by small- and medium-sized banks is the recent wave of debt defaults by state-owned enterprises. SOEs issue sizable debt, and many financial institutions are willing to buy their bonds because there is an implicit understanding that the CCP government will always bail out underperforming SOEs and help them fulfil their debt obligations. However, the fact that the Henan provincial government “allowed” Yongcheng Coal & Electricity Holding Group, a top local SOE, to default on its bond suddenly raises questions about the credibility of local government guarantees and the creditworthiness of the CCP regime in general. With more SOE defaults looming on the horizon (Yongcheng “breaking the taboo” of defaulting on its debt will inspire others to do the same per the political culture in the PRC), small- and medium-sized banks in China face substantially higher risks of bankruptcy in the near future.
Finally, should the CCP adopt a “one size fits all” approach to resolving current financial problems, it would only raise financial risks for small- and medium-sized banks and trigger a systemic financial crisis.
3. China’s debt “icebergs” are surfacing, but much is still hidden beneath the waters. Both private and government companies will find it harder to sell bonds and secure refinancing as more SOEs start defaulting and banks undergo “restructuring” or file for bankruptcy. The triggering of systemic financial risks will hasten the arrival of political Black Swans in the PRC, which will in turn push the CCP regime closer to a “Berlin Wall” moment.
SinoInsight 2
On Nov. 23, the PRC government released an online statement about premier Li Keqiang’s web meeting with officials from Guangdong, Heilongjiang, Hunan, Yunan, and Shandong provinces on Nov. 20. Li asked the officials to be frank about their overall economic performance for the year, what their economies need for the next step, and their specific suggestions for the national economy. He encouraged the officials to “put aside their notes” and make presentations based on the three questions he raised. Li said, “only when you tell the truth, can we come up with practical measures.”
On the same day, the CCP claimed that extreme poverty had been eliminated in China after “certifying” that nine counties in Guizhou had crossed the PRC’s poverty threshold to become “poverty-free.” Party and state propaganda outlets gave plenty of attention to the “achievement.” Xinhua’s article on the topic was one of the top articles in the important news column on the left-hand side of its home page, and CCTV’s “Xinwen Lianbo” primetime program devoted a segment to poverty elimination.
OUR TAKE
1. At a glance, “eliminating poverty” seems like quite an achievement for the CCP. Aside from underlining the “ability” of the CCP’s authoritarian system to set a goal and meet it, the regime is also signaling that it puts the people’s interests first by “eliminating poverty.”
However, an examination of the CCP’s poverty benchmarks and political culture tells a different story.
2. The World Bank’s poverty line is set at $1.90 a day. Assuming a USD to RMB exchange rate of 6.6, the average annual income a person should be making in China is 4,577 yuan. This figure is 13 percent higher than China’s current poverty line of 4,000 yuan per year as announced by Liu Yongfu, director of the State Council Leading Group Office of Poverty Alleviation and Development, during a March 13 press conference. Put another way, what counts as “eliminating poverty” in China does not meet global standards.
In considering that deception and “preferring left rather than right” (寧左勿右) are deeply ingrained in CCP political culture, there will always be a discrepancy between what it means to “eliminate poverty” in China versus elsewhere. Genuinely alleviating poverty is almost never the true preoccupation of CCP officials, but meeting “poverty alleviation” targets to accrue political capital is. Endemic corruption in the officialdom also means that funds meant for poverty alleviation projects frequently end up in the pockets of officials instead. Meanwhile, the needs of the Chinese people are often disregarded.
A Nov. 20, 2019 report in state media Beijing News offers a glimpse at how “eliminating poverty” works in the CCP. To meet Beijing’s poverty alleviation requirements, the local Party committee of Chawei Village in Yunnan Province summoned a local villager to sign a document certifying that he was no longer below the official poverty line because the authorities claimed he was earning 5,811.76 yuan per year. However, the villager refused to sign the document because he had “nothing to gain,” and what he stood to “gain” was already being “enjoyed by those with good relations” with the village Party committee. In other words, the villager was supposed to be taking government subsidies for being below the poverty line but never saw those subsidies due to official corruption, and is now being made to sign a document claiming that he was no longer in poverty.
3. CCP officials in the rank and file are not the only ones who need to meet “poverty alleviation” goals. Xi Jinping, who set the goal of “eliminating poverty” in 2020, also has pressing need to “hit” his target and score political points to boost his “quan wei.” Xi’s “quan wei” and political standing are not as solid as observers presume, and he has dire need to show results to perpetuate his strongman model and marginalize the “collective leadership.” Otherwise, Xi faces an uphill battle to secure a third term in office at the 20th Party Congress in 2022, especially with the many domestic and foreign failures under his leadership.
We previously looked at how Xi reframed setbacks as victories and took credit for coronavirus prevention work, food shortages, and the persecution campaign in Xinjiang Province to solidify his paramount position in the regime.
4. Has the CCP truly “eliminated poverty” in China, even by its lowered standards? A closer examination of current realities suggest that Beijing is merely engaging in propaganda.
First, the Chinese economy is presently not healthy enough for the propaganda to be believable. Rising tides lift all boats, but the CCP was unable to alleviate poverty a decade ago when the Chinese economy was booming. That the CCP somehow managed to uplift the poorest parts of the country now when the Chinese economy has deteriorated rapidly in recent years and with a coronavirus pandemic wrecking still more economic damage defies common sense.
Second, Li Keqiang’s Nov. 20 meeting and exhortations for officials to “tell the truth” about their local economic situation indicates that Beijing is not optimistic regarding China’s economic outlook and does not trust its own official data. This is not the first time that Li has indirectly expressed a lack of faith in government figures; back in 2007 when he was Liaoning Party boss, Li told a U.S. diplomat that he looked at three indicators (railway cargo volume, electricity consumption and loans disbursed by banks), or the so-called “Li Keqiang Index,” to have a better sense of how the local economy is really performing because official GDP figures are unreliable. The fact that Li Keqiang is calling for “truth” from local officials about the economy at this time suggests that the Chinese economy has not really “recovered” as claimed in propaganda but is doing much worse than Beijing believes.
Third, it is perhaps not a coincidence that news of “poverty elimination” came out on the same day as news of Li’s meeting with local officials about the economy. Beijing is likely looking to concurrently boost its standing (and Xi Jinping’s credibility) with the people by touting success in “alleviating poverty,” while subtly warning officials that the CCP is facing regime-threatening economic problems and that they should do their best to support Party Central.
