CCP choices: Inflation bad, Contraction worse?

China could use its foreign currency reserves to recapitalizes its banks – if need be -, believes Victor Shih (史宗瀚), assistant professor of political science at Northwestern University. The amounts the banks were ordered to lend to keep the economy going during the global financial crisis may contain a high share of non-performing loans – not least those to local government investment companies which, Shi is quoted as saying, had a generally poor financial status even before the surge in infrastructure projects which constituted the first Chinese stimulus package. And if they weren’t ordered to lend, let’s say that commerical banks’ credit ceilings were to be abolished late in 2008.

Shih estimates that local governments have accumulated debts of 11.4 trillion yuan RMB by the end of 2009, or roughly a third of China’s GDP of the same year, and would need 12.7 trillion more by the end of this year.  25 per cent of the latter would turn bad, the Wall Street Journal (China Real Time) quotes Shih.

If that turned out to be the case, the banks would need to recapitalize, says Shih – and China’s foreign exchange reserve could offer the means, probably by having the banks issue new shares overseas, then have China Investment Corp. – the country’s sovereign wealth fund – buy the shares using dollars.

According to a Voice of Germany (Deutsche Welle) report, the credit ceilings were indeed lifted. And two-thirds of the stimulus package (total: 26 trillion, according to the Welle) weren’t paid for by the central government (as JR believed in 2008), but by the local governments. The Welle quotes Victor Shih as saying that the country’s leadership neglected the debt issue for political reasons. Shih told foreign journalist in Beijing that as of November 2008, some 8,000 local investment companies took loans of at least 11 trillion – seven times the total revenues of local governments. The central government was facing a choice between quickly issuing restrictions on the flow of money, or let bad loans and inflation spread. “China’s leadership may prefer to let inflation rise, and to continue to make the banks lend money. They may not even wish to allow a healthy contraction, before determining the next generation of party leaders.” (即便是健康地收缩贷款发放,在下届决定下一代中国领导人的党代会召开之前,他们也不会愿意。)

[Update, 20130729: While the original Deutsche-Welle link is no longer available, it can apparently still be found in this online discussion]

While the foreign exchange reserves could be useful in rebalancing the financial system, Beijing would prefer to use them as checks and balances in its relations with Washington. Some Chinese economists suggested to increase the property tax rate to curb local loans, but provincial governments would hardly support that. “They are themselves players in the real estate game. […] Even if you say, we will cancel  your debts [我们还掉你的欠债 – my reading of 掉 (diao) is to cancel – JR], they won’t like that, because this is related to the question of how to make money besides that amount, and the real estate market is still developing. Besides cancelling [see previous disclaimer – JR], you will need to pay us another big amount of money. Otherwise, we won’t act in accordance with what you say.”

According to the Wall Street Journal report, Shih, apparently also during the talk to journalists in Beijing (which was on Wednesday), pointed out that he didn’t say there would be a financial crisis. “I’m saying it’s going to be a costly process to restructure and recapitalize the banks.”

At the Crossroads: China’s Development, February 20, 2009
Guangdong: Credit Constriction, October 2008

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