China squeeze is hampering Asian growth

February 11, 2014 8:17 am

China squeeze is hampering Asian growth

By Henny Sender

Fed tapering raises the focus of China’s role as liquidity provider

Amilestone of sorts was reached last year when for the first time ever, more bank credit as a percentage of GDP went to emerging markets than to developed markets.

That is not exactly counterintuitive, since emerging markets, especially in Asia, have always relied heavily on credit to fuel their growth.

When the European banks seized up following the globalfinancial crisis

that began in the US, the concern was almost as great in Asia as it was in Europe itself. The concern was especially intense because European banks accounted for a huge part of trade finance, the lifeblood of Asia. At that time, though, regional banks were able to largely fill the gap. Moreover, the US Federal Reserve was about to flood the world with liquidity, with much of it flowing to emerging markets. The cost of capitalremained low, allowing these markets to continue to grow.

Now though, these benign trends are reversing – and arguably there is worse to come. The cost of capital is going up for emerging markets and as it does so, growth will slow. That in itself is unlikely to trigger a crisis but will lead to problems for many indebted emerging market companies, fuelling bad debts at the banks. That in turn will make the cost of capital go even higher.

China is a big factor in this new dynamic. Today, the world is focusing on the implications of slower growth in China. But it also needs to start focusing on the role of Chinese banks as a source of liquidity for neighbours and emerging markets generally.

China liquidity crunch

Any capital crunch in China is not immediately obvious. So far, much of the concern over China has to do with excessive credit growth, which is now close to 180 per cent of GDP. A new study from the Institute of International Finance shows that Chineseinternational bank loans amounted to almost $100bn last year, a jump of more than 60 per cent since 2011, (the figure excludes Hong Kong, Macau and Taiwan).

Since the study relies on data on publicly announced loans, that number probably understates the extent of activity. Moreover, Chinese banks lend to corporate borrowers that otherwise might have trouble attracting capital, such as in Pakistan or Bangladesh.

But excess credit growth may soon be yesterday’s problem. As the Chinese regulators put pressure on the shadow banks by implementing periodic liquidity squeezes, they will chill all banking activity and make the price of all money more expensive, since the line between the regulated and unregulated world is so porous.

In addition, the dynamic at home is also changing the way the Chinese banks price their money. Competition from the shadow banks that can offer much higher returns than banks that set deposit rates artificially low means household savings are increasingly less likely to go into bank deposits. That in turn means banks have an increasingly hard time giving loans to favoured borrowers at artificially low rates. Now, Chinese banks are having liquidity troubles of their own, compelling them to ask borrowers not to draw down credit lines.

Rules making it difficult for whole classes of borrowers, such as property developers, to access credit at all mean some Chinese borrowers are going offshore to international capital markets for capital and competing with other borrowers in the process, driving up prices there too. International debt securities from Chinese issuers rose by a factor of five from the end of 2009 to the end of the third quarter of last year to a total of $240bn, according to data from the Bank for International Settlements cited by Christopher Wood, an analyst at CLSA.

Borrowers paying more

Other sources of liquidity for Chinese banks are also drying up. Executives at international and regional banks that have provided funds to second tier Chinese banks in the wholesale market say they are cutting back, concerned about declining creditworthiness of such counterparties.

All this would matter less if there was less confusion about the state of the US economy and Fed policy. The disparity in analyst predictions about where 10-year Treasury yields will be in coming months is becoming wider by the day. Analysts at HSBC say the rate could go as low as around 2 per cent, while others see the rate rising to more than 3.5 per cent.

Regulators appear to be speaking with forked tongues. Some are still wedded to low rates. But at the same time, they are either trying to squeeze the shadow banks, as in China, to drive activity into the official sector, or they are squeezing the banks, driving activity into the shadow banks, as in the US.

In either case, they may or may not be making their financial system safer – but they are surely making the cost of money go up for most borrowers in the real world.

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 (, 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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