SinoInsight 1
Oct. 23
1. Mainland media reported that a private placement bond issued by Shenyang Shengjing Energy Development Group was deemed to have matured recently owing to the company filing for bankruptcy. The bond, “18 Shengongyong PPN001,” was issued in August 2018 at a value of 80 million yuan, a coupon rate of 7 percent, and a maturity of three years (Aug. 10, 2021). Another bond issued by Shengjing Energy, “17 Shengongyong PPN001” (420 million yuan in value), also matured early due to the company’s “technical default.” The 500 million yuan that Shengjing Energy owed to bondholders was covered by Hanhua Insurance.
Shengjing Energy is an AA-rated urban investment platform based in Liaoning Province. The company is a local state-owned enterprise controlled by Shenyang City’s State-owned Assets Supervision and Administration Commission (SASAC). The markets consider Shengjing Energy to be the first “urban investment platform failure” case in China.
2. Mainland media reported that a $1 billion yuan private placement bond (“17 Huaqi 05”) issued in October 2017 by Brilliance Auto Group, an automobile manufacturer based in Shenyang City, failed to mature due to problems with the company.
Since May 2020, Brilliance Auto has shown signs that it would default on bonds and is experiencing a liquidity crunch, including accusations the company breached contracts, had frozen equity, established a “debt committee,” and is selling company stake, etc.
According to financial data provider Wind, Brilliance Auto has 14 bonds worth 17.2 billion that have not reached maturity. The company is a key SOE under the Liaoning provincial SASAC, and was AAA-rated at the end of September 2020.
Oct. 30
1. Twenty-eight Chinese banks issued 491.3 billion yuan (about $73.409 billion) worth of perpetual bonds this year as of Oct. 29, according to the state-run China Securities Journal, citing data from Wind.
Of the 28 banks, four were large state-owned entities, and they issued 270 billion yuan of perpetual bonds (54.96 percent of 491.3 billion yuan). Another four were joint-stock banks, and they issued 150 billion yuan worth of bonds (30.53 percent). The remaining 14.51 percent of perpetual bonds were issued by various urban, rural, and agricultural banks.
2. Various mainland media report that China’s five largest state-owned banks (Bank of China, China Construction Bank, Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of Communications) are seeing falling profits and rising bad debts. One report notes that net profits of all five banks declined over 8.7 percent year-on-year, with the Bank of Communications seeing the steepest drop at 12.36 percent from 2019.
Mainland media also count at least 1,300 closed bank outlets and branches in the first half of 2020. Meanwhile, four of the five big state banks (Bank of China, China Construction Bank, Industrial and Commercial Bank of China, Agricultural Bank of China) have laid off a total of 26,000 employees over the same period.
According to a Securities Daily report, nearly 100 Chinese banks recently released their financial reports, and those reports reflect a sharp drop in profits. As many as 75 percent of the banks reviewed by Securities Daily reported losses, with 31 banks seeing declines in net profits of more than 10 percent year-on-year. Only 5 banks saw net profits go up by over 20 percent.
OUR TAKE
1. We believe that declining profits for China’s top five major state banks and “technical defaults” of bonds issued by local SOEs foreshadow the triggering of systemic financial risks and debt crisis in China. China’s economic growth and prospects, which are driven by debt, is not as optimistic as depicted in CCP propaganda and by mainstream Western media outlets or commentators. The examples we have listed above suggest that Gray Rhinos are beginning to charge in China.
2. The CCP has been attempting to boost the economy by issuing more government debt and investing in infrastructure. This strategy, however, has not helped China’s economic recovery, with the government’s tax revenue shrinking. If anything, the strategy is compounding China’s debt crisis.
According to official CCP data, China’s total social financing increased 15.4 percent from a year ago during the January-September period to 29.62 trillion yuan. Government bonds account for 22.7 percent (6.73 trillion yuan) of the increase in total social financing for the January-September period, or 42.6 percent higher than the increase of government bonds for the whole of 2019 (4.72 trillion yuan).
The government bonds included in China’s total social financing comprise only those issued by the central and local governments. They do not include urban bonds issued by various local government financing vehicles (such as Shengjing Energy). Urban bonds are counted as part of the People’s Bank of China’s corporate bonds. According to Wind, urban bonds grew 59.1 percent (1.6542 trillion yuan) in the first three quarters of the year as compared to the whole of 2019 (1.0397 trillion yuan). If we count urban bonds as part of government bonds, then the latter would account for 28.3 percent (8.39 trillion yuan) of the increase in total social financing for the first three quarters of 2020.
The available figures, however, only represent the tip of the government debt iceberg. Based on previous estimates, government implicit debt in China may be triple or quadruple the figure for explicit debt.
3. China’s debt is growing and economic recovery is questionable.
In the first three quarters of the year, the PRC government’s fiscal deficit grew 56.7 percent over the same period a year ago to 5.7194 trillion yuan, according to official figures. The deficit is 29.1 percent of total government in the first three quarters (19.62 trillion yuan). Given the current trajectory, China’s annual fiscal deficit is likely to exceed 7 trillion yuan for 2020.
Additionally, in the first three quarters of 2020, China’s fixed-asset investments contracted 5.3 percent in absolute terms to 43.65 trillion yuan year-on-year. The proportion of private investment to total investments fell to 55.9 percent. In 2015, private investments peaked at 64.2 percent of fixed-asset investments. By 2019, private investments had fallen to 56.4 percent.
The decline of private investments in China suggests that the CCP’s policy of expanding debt to stimulate the economy is failing. The economy has not actually recovered as touted, and the Chinese people’s spending power is shrinking.
Another benchmark of China’s economic recovery is passenger traffic, which reflects consumer activity and spending ability. Official data shows that China’s passenger traffic contracted 49 percent year-on-year during the January-September period to 6.806 billion trips. Passenger traffic was also lackluster during the “Double Ten” holiday period in China; average daily passenger traffic shrank 19.5 percent over the same period in 2019 (19.71 million trips) to 15.86 million trips.
4. The PRC government’s debt (excluding implicit debt) accounts for nearly 30 percent of total societal debt. The PRC’s ability to service its debt, however, is very poor, as it frequently relies on rolling over debt or issuing new debt to pay off its old ones. This has resulted in an accumulation of debt risks in the financial system.
In May 2018, He Keng, vice chairman of the Finance and Economics Committee of the National People’s Congress, said that no local government wants to repay their debts, and many cannot even afford to pay interest on their bonds.
China’s small- and medium-sized banks have had liquidity problems in the past two years. With profits from China’s five largest state banks declining and their bad debts increasing, this suggests that smaller banks are likewise also doing poorly, with negative implications for the Chinese economy.
In 2019, China’s A-share listed companies made total net profits of 3.78 trillion yuan, of which 44.2 percent were profits from listed banks (1.67 trillion yuan). That year, the net profit of the six largest state-owned banks was 1.14 trillion yuan, or 57 percent of the overall profit of listed banks.
The banking sector’s woes indicate that China’s economy is unhealthy, with financial risks rising. When China’s most profitable state-owned banks make less than before, other industries are likely performing even worse. Poor economic performance will affect the PRC government’s fiscal revenue, which will in turn worsen the debt crisis facing Chinese banks.
SinoInsight 2
The CCP has been talking up its “food security” recently. On Oct. 15, Zhang Wufeng, head of the PRC National Food and Strategic Reserves Administration, said during an interview with Xinhua that China has “abundant stocks, sufficient reserves, and abundant supplies.” He added, “food security continues to improve” and China’s ability to “guarantee food security has withstood the test of the epidemic.” On Oct. 21, a spokesperson from the PRC Ministry of Agriculture and Rural Affairs said at a press conference that China’s “agricultural and rural economy has maintained a positive and steady situation. Bumper harvests are a foregone conclusion and production is expected to reach the best on record…”
Back in September, Minister of Agriculture and Rural Affairs Han Changfu said that China will see “bumper harvests” this year despite three consecutive typhoons ravaging corn belt areas in northeastern provinces.
Official statements, however, are being challenged by information leaks on Chinese-language social media and some mainland media outlets.
In the past fortnight, food processing companies in several major agricultural regions in China (Hubei, Hunan, Jiangxi, etc.) issued nearly simultaneous notices on significant price hikes. According to the notices, rice production has been cut by as much as 30 percent (due to “shortages and the pandemic,” or “severe conditions,” some notices claim), and prices are expected to rise by at least 200 to 500 yuan per ton (about 7 percent to 17 percent), from 2,900 yuan per ton on Oct. 26. Also, rice mills across China are snapping up available harvests, with some areas seeing shortages to the point where demand exceeds supply, with companies unable to purchase even with cash in hand. Some food processing companies announced they will adjust the price of rice to the purchase price for the day “due to fierce competition in the market.”
According to mainland media reports, prices for three major food staples—rice, wheat, and corn—have spiked in the first three quarters of 2020, with corn prices hitting a four-year high. The reports say corn prices have been rising since 2017 for nearly four consecutive years, with the average price of spot corn now exceeding 2,600 yuan per ton, or over 1,000 yuan more compared to the end of 2017 (up 62 percent).
Western media also hint at grain shortages in China. According to an Oct. 23 Reuters report, China, “which needs about 280 million tonnes a year of corn, previously held massive reserves but has almost emptied them at auctions.” Three industry sources told Reuters that China is “expected to issue more import quotas and buy millions of tonnes of additional corn in the new crop marketing year,” reportedly due to “a surge in animal feed demand and tightening supplies.” China has also “booked cargo shipments far exceeding the official annual quota level for corn” so far this calendar year. One of the sources said that China is importing more corn because “we do need corn” and to fulfill the Sino-U.S. “phase one” trade deal.
According to mainland media, China has already imported 17 million tons of corn this year. However, the PRC State Council’s Development Research Center previously estimated that China would need to import 20 million tons of corn in 2020 to bridge the supply-demand gap. The PRC will have to import an additional 3 million tons of corn in these next two months to cover the shortfall.
OUR TAKE
1. We have repeatedly warned of a food crisis in China stemming from corruption, the coronavirus, and natural disasters this year (see here, here, here, and here). The recent information leaks about rising food prices and shortages affirm our analysis.
Also affirming our analysis is the CCP’s continuous food shortage denial statements, which grow increasingly exaggerated (“best period in history for food security” despite the coronavirus, natural disasters, etc.) and incredulous (“bumper harvests” despite typhoons flattening the corn belt). The CCP’s food propaganda is a classic case of outright deception, and “spinning tragedy into cause for celebration” (喪事當喜事辦).
2. A food crisis in China, coupled with rising unemployment and other coronavirus-related factors, will lead to greater social instability. Greater social instability will force central and local governments to invest more money and resources into the public security bureau in particular and the political and legal affairs apparatus to “maintain stability,” resulting in a greater strain on the regime’s finances.
Per the CCP’s characteristics and mode of operations, it will attempt to cover-up any humanitarian disaster resulting from food shortages. This includes strict censorship and increased propaganda efforts at home and abroad. The CCP will prioritize the welfare and supply of first and second-tier cities while insisting that “all’s well” to keep attracting foreign investment to China. Meanwhile, rationing could be imposed upon third and fourth-tier cities, and rural areas.
Businesses, investors, and governments must see past headlines, before determining China to be a “financial safe haven” that has “overcome the virus” in all aspects.
