The unexpected withdrawal by hurdler Liu Xiang from participation in the Olympics – because of a leg injury – has been a real emotional blow to many of my friends and students in China. Condolences to all. It is a disappointment to see such a great athlete unable to defend his title in his own country. Sad as his withdrawal has been for many of us here, there is still a lot to be excited about as the Olympics wind down. Tomorrow I will see Brazil play Argentina in the soccer quarterfinals, thanks to the generosity of my former Tsinghua student Richard Zhang, now a rising star at McKinsey, and on Wednesday one of my favorite Beijing musicians, Shouwang, is taking me to see track and field events at the Bird’s Nest (finally I get to see the magnificent stadium from the inside!).
But not all the news is Olympic-related. Xinhuareports today that the first half of 2008 saw a slowdown in the growth rate of loans to real estate developers and buyers. According to the article:
Chinese bankers held loans totaling 5.2 trillion yuan (about 580 billion U.S. dollars) to real estate developers and housing buyers by the end of June, up 22.5 percent year-on-year, the People’s Bank of China (PBOC) said Friday.
The central bank said the growth rate was two percentage points lower than the same period last year, representing a decline for seven consecutive months since last December. Loans to real estate development stood at 1.9 trillion yuan by June, up 17.7 percent year on year. The growth rate was eight percentage points lower than the same period last year.
The country’s lenders granted 3.3 trillion yuan to housing buyers buy June, representing an increase of 25.6 percent year on year. The growth rate was 1.8 percentage points higher than the same period last year. Real estate developers and housing buyers received 398.84 billion yuan in loans between January and June, which was 170.66 billion yuan less than the same period last year, said the PBOC.
China’s real estate investment grew fast in the first half, but the housing price decline in some cities has strengthened a wait-and-see attitude among housing buyers, which retarded housing sales. The country’s real estate developers sold out about 260 millions quare meters houses in the first six months, and the sales value totaled one trillion yuan, representing an decrease of 7.2 percent and 3.0 percent over the same period last year, respectively.
The PBoC had been warning banks to control their exposure to real estate. Obviously the banks are responding, although 22.5% growth year on year is nothing to sneer at, and it should be pointed out that the growth rate in real estate loans still exceeds total loan growth, so as a proportion of total loans real-estate-related loans have not declined at all. Still, with real estate exposure in the banks (formally recognized as such or, in many cases, not) creating probably the biggest worry for the PBoC in case of a slowdown in economic growth, this is relatively good news.
It is clearly a good thing that the PBoC is worried about and monitoring real estate exposure. Among the many problems faced by the banking system, a sharp decline in real estate prices is probably the biggest single risk. The still unanswered and vitally important question for me, I think, is about real-estate-related loans in the informal banking sector. There is a lot if anecdotal evidence of developers turning to the informal banking sector – in spite of short maturities and high interest rates – as a replacement for the restricted funding provided in the past by the formal banking sector.
I don’t know whether or not there is a similar moderation in the rate of new lending among informal banks, but the worrier in me thinks probably not. At first glance this might seem not to matter. If informal banks go bust because of excess exposure to bad real estate loans, it might not seem to matter to the formal banking and payments system, and so might have limited impact on the loan portfolios of the large banks and, via the banks, on the underlying economy. Without knowing the links between the informal and formal banking systems, however, this optimism might be unwarranted. I can think of at least three ways in which problems in the informal banks can spread:
1. A decline in real estate prices can be exacerbated by forced liquidation of real estate loans extended by the informal banks.
2. Formal banks may find themselves unexpectedly in a junior credit position if assets owned by a company turn out to have been used to collateralize loans from informal banks.
3. Informal banks may have directly or indirectly obtained funding from the formal banking sector.
On a related note I got an interesting email today from one of my former Peking University students. He says (with some editing on my part):
I just talked to a friend in a city in the south. Interestingly, he tried to pay back his mortgage loan last week, and get another 3 year loan again (many entrepreneur there rely heavily on this kind of financing as working capital, sometimes, from informal banks of course). However, he was told that the term of next loan had to be just 1 year instead of the usual 3 yrs, and he has to go through the application process again every year.
Collapsing property and other assets prices in some cities like Shenzhen seem to have made banks cautious of a probable rise in default risk, and the tightening will hurt these small enterprises further.
I don’t know how widespread this shortening of maturities is, but a common problem in banking is that when risks are perceived to have risen, lenders often respond (rationally, in the case of each individual bank or investor) by readjusting their portfolios in ways that increase overall riskiness in the system.
For example as lenders became increasingly worried about the risks in Mexico in 1994, one of the consequences was a surge in short-term borrowing by the Mexican government as creditors became increasingly reluctant to extend long-term loans. This of course increased the risks of a liquidity contraction to the Mexican government, and when that contraction happened, the Mexican government came close to defaulting.
This happens all the time as the perception of risk rises. I wouldn’t be surprised – if there were an effective way to measure loan maturities for all loans in the system, including those extended by the informal banking sector – to see that average loan maturities in China have declined substantially in the past several quarters. This, of course, increases the overall liquidity risk in the system.
Meanwhile the stock market continues to plunge. On Friday the market experienced its first and only up date since the Olympics started, rising 0.9% to close at 2451. Today it changed direction dramatically and dropped 5.3% to close at 2321 (this in spite of a 58% first-day jump – which is pretty mild by Chinese standards – in share price for the $1.5 billion IPO for South Locomotive and Rolling Stock).
The Thursday before the Olympics started, the market closed at 2728, so we have seen a total decline of 14.9% during the past eleven Olympic days (seven trading days). I wrote in an August 11 entry that before the Olympics end we might see the market test 2300, the level below which their have been rumors that the government will intervene. We are now less than 1% away from that level and we still have the rest of this week to go.
It is not completely clear why the markets have behaved so poorly in the last week, although the answer is probably multiple. A lot of analysts are worried about a slowdown in economic growth, the possibility of an increase in inflation still scares many (as it should), and there is a lot of concern about dilution effect of a possible upcoming sale of non-tradable shares as these become tradable. There is also worry that hot money inflows may have already begun to reverse themselves (for example see this ChinaStakes.com article). This perception comes from the widespread belief that the increase in foreign exchange reserves in June was substantially less than the combination of FDI, trade surplus, and other identified inflows.
Actually this perception is incorrect, and represents mistakes in the way most analysts count the rise in PBoC reserves. I discuss why true growth in June’s foreign exchange reserves actually exceeded the identifiable inflows in a July 14 entry. I don’t think hot money outflows are likely to be the main culprit behind the declining stock market, but I don’t discount the possibility that, as the perception of China’s riskiness increases, and as concern grows about the imposition of further restrictions on short-term inflows and outflows, we may begin to see at least some hot money reverse direction and leave the country.
On a related topic, today to a large fund manager asked me whether or not it made sense to buy Chinese stocks at these levels. From a short-term trading point of view I am not sure I would be in a hurry to buy because I still think we are going to face a post-Olympic hangover that may affect the markets. I think at least part of the surge in consumer spending last month and this month will have been Olympic related (new TV sets and entertainment units, Olympic souvenirs, sports equipment and clothing, flags, traveling to Beijing, and the kind of spending that comes from exuberance at China’s sporting triumphs), and this is likely to be reversed in the September and October numbers. That should keep downward pressure on the market.
On the other hand over the medium term a number of Chinese stocks probably represent good value. I haven’t looked at the discount between A-shares (which only Chinese nationals can buy) and B-shares (which foreigners are permitted to buy) in several months because I closed out all my positions much earlier this year (thank the gods!), but because of lower liquidity B-shares have typically traded at a 30-40% discount to A-shares. If this continues to be the case, I think a very strong case can be made for the selective and gradual acquisition of a diversified portfolio of B-shares, especially in the more defensive industries and less leveraged companies.
Originally published at China financial markets and reproduced here with the author’s permission.