China Failure to Grow With $1 Trillion Credit Seen as Li Warning

China Failure to Grow With $1 Trillion Credit Seen as Li Warning

By Bloomberg News  May 29, 2013

China’s economy is proving less responsive to credit, escalating pressure on Premier Li Keqiang to strengthen the role of private enterprise.

The government’s broadest measure of credit rose 58 percent to a record 6.16 trillion yuan ($1 trillion) in January-to-March, when gross domestic product gained 7.7 percent, compared with 8.1 percent a year earlier. Each $1 in credit firepower added the equivalent of 17 cents in GDP, down from 29 cents last year and 83 cents in 2007, when global money markets began to freeze, according to data compiled by Bloomberg.

The diminishing returns to lending heighten focus on the need for what the International Monetary Fund said yesterday are “decisive” policy changes in the world’s second-largest economy. Without a refocus away from state-approved projects, Li and President Xi Jinping risk overseeing both a further slowdown in growth and an increase in non-performing loans.“Less efficient and more highly leveraged borrowers have been kept afloat, tying up credit that could be used to generate more growth,” said David Loevinger, former senior coordinator for China affairs at the U.S. Treasury Department. “To boost growth, China needs to channel more financing to its private enterprises, which are both more profitable and less leveraged than their state-owned counterparts.”

State enterprises have seen their return on equity fall by half in six years, according to CLSA Asia-Pacific Markets in Hong Kong. The biggest concern from China’s credit surge is the money going to companies and state-run enterprises whose performance is deteriorating, Francis Cheung, head of China-Hong Kong strategy, wrote in a May 9 report.

Bond Market

Signals from China’s bond market, which has expanded 39 percent so far this year compared with the same period in 2012, indicate businesses are struggling to improve profitability even with greater access to credit.

Borrowing in the debt market by the biggest Chinese companies is more than five times a measure of their operating earnings, twice the leverage ratio in 2007, according to data compiled by Bloomberg. State-owned enterprises in energy and power production are among the biggest borrowers, including China National Petroleum Corp., the nation’s largest oil producer, and China State Grid Corp., the country’s largest power distributor.

Among 102 non-financial companies in the MSCI China Index, total debt over earnings before interest, taxes, depreciation and amortization rose to 5.74 times based on the latest filings through May 28, from 2.49 times in 2007.

Solar Loans

One example of what Loevinger, now an emerging-markets analyst in Los Angeles at TCW Group Inc., called “inefficient and leveraged borrowers,” may be LDK Solar Co. (LDK), a maker of solar panels. The company, which cut solar-cell production capacity by 89 percent last year, said in April it’s in the process of getting a new loan facility of about 2 billion yuan.

With debt of $3.1 billion, seven straight quarterly losses and cash at a three-year low, LDK needs access to funds “to get through this very challenging time,” Chief Financial Officer Jack Lai said on an April 18 conference call. The announcement came after larger competitorSuntech Power Holdings Co. (STP)’s biggest unit was forced into bankruptcy in March.

The 2014 yuan bonds of LDK, which failed to fully repay $23.8 million of convertible notes in April, slid to a seven-month low of 34 yuan per 100 yuan face value earlier this month.

Reduce Role

Since taking office in March, Li has pledged to reduce government interference and boost the role of private companies. He said March 17 that cutting the government’s power amounted to a “self-imposed revolution” and earlier this month signaled in a speech broadcast to government officials around the nation that he would prefer relying on “market mechanisms” for growth rather than stimulus or direct government investment.

China’s leaders are already experimenting with some changes, including to the household-registration system that hampers urbanization. Other reforms, such as to land rights and income distribution, may be decided later this year at a Communist Party forum.

Xi and Li have signaled they’re willing to tolerate slower growth if it’s more sustainable in the longer run and provides a better quality of life for the nation’s 1.35 billion people. Xi said May 24 that the environment won’t be sacrificed to ensure short-term economic expansion, as the government faces rising public discontent over pollution and food safety issues.

Annual Pace

Li said this week that 7 percent average annual growth is needed this decade as the country seeks to double per-capita income. That’s lower than the 7.5 percent target the government set in March for this year.

Forty-one percent of respondents in a Bloomberg global poll of investors this month saw China’s average growth rate falling to 6 percent to 7 percent over the next five years, while 18 percent said it will slump to less than 6 percent. Even with an 81 percent increase in credit in April from a year earlier, manufacturing contracted in May for the first time in seven months, according to the preliminary reading of a Purchasing Managers’ Index from HSBC Holdings Plc and Markit Economics.

David Lipton, the IMF’s first deputy managing director, warned yesterday that rapid credit growth “raises questions about the quality of the investment and the impact that may have on repayment capacity” for companies and local governments. China’s leaders have assured the IMF that reining in credit expansion is a priority, Lipton told reporters in Beijing.

Restrain Spending

China had snapped seven quarters of decelerating growth in the fourth quarter only to slow again in the first three months of 2013. Europe’s debt crisis is curbing shipments abroad, manufacturing gains are weakening and a government anti-extravagance campaign hasrestrained restaurant and retail sales.

“Such stalling is extremely rare in recent macroeconomic cycles,” Stephen Green, head of Greater China research at Standard Chartered Plc in Hong Kong, wrote in a May 10 note. “Once China’s growth starts accelerating, it usually continues.”

Green sees the injection of credit fueling an uptick in output toward the end of this quarter and next, when he forecasts growth edging up to 7.8 percent as housing, infrastructure and exports strengthen.

Companies may be holding some of the new credit in reserve in bank deposits, according to Michael Werner, a banking analyst with Sanford C. Bernstein & Co. in Hong Kong. A 3.1 trillion yuan increase in corporate bank deposits in March may indicate companies front-loaded lending to guard against any crackdown on credit channels after Xi and Li took office, he said.

Economic Effect

“That tells me that not all of the money has been allocated yet into the economy,” Werner said.

The diminishing impact of credit on growth shows that companies are restraining investment because they recognize that the “outlook for sustainable final demand is weak” unless new policies boost household consumption, said Ramin Toloui, the Singapore-based global co-head of emerging markets portfolio management at Pacific Investment Management Co., manager of the world’s biggest bond fund.

“China’s challenge used to be to mobilize the factors of production — labor, capital, and technology — to service boundless global demand,” Toloui said. “Now the challenge is to unleash the potential of Chinese households to serve as sources of that demand.”

–Kevin Hamlin, with assistance from Zhou Xin, Sarah Chen and Nerys Avery in Beijing, Andrew Monahan in Hong Kong and David Yong in Singapore. Editors: Scott Lanman, Peter Hirschberg

To contact Bloomberg News staff for this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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