Since the spread of the Wuhan coronavirus (now officially named Covid-19 by the World Health Organization), China has employed every monetary and fiscal instrument under the Rising Sun. To limit the economic fallout from the outbreak, Beijing is doing everything from sterilizing cash to cutting interest rates. The plan is to survive until tomorrow. The quintessential question right now is: Will attempting to shield and sustain the economy from the coronavirus for another 24 hours eventually trigger an inescapable economic collapse in the years to come?
Medicine or a Sugar Pill?
President Xi Jinping and his government have introduced a series of fiscal stimulus measures, including across-the-board tax cuts, quick approval of major construction projects, and raising the annual budget deficit ratio from 2.8% to 3.1%. Beijing is even allowing municipal governments to issue more bonds to cover infrastructure spending. In a recent televised speech, Xi hinted at additional fiscal efforts to ensure the world’s second-largest economy can cap the economic damage.
Ditto for the People’s Bank of China (PBoC), which recently cut the medium-term lending interest rate by ten basis points to 3.15%, the lowest level in about two years. The rate cut will inject about $29 billion of one-year medium-term loans into the open market to help support virus-hit financial institutions.
Over the last month, the PBoC executed a wide array of monetary actions, including injections of more than $200 billion in liquidity to cushion stocks, stabilize markets, and ensure banks can weather the coronavirus outbreak. The central bank also has encouraged lenders to keep lending to borrowers in areas that have been hit the hardest by the virus, and officials are urging businesses to “tolerate” bad debts. The PBoC is going as far as mandating banks to disinfect deposits using ultraviolet light and holding on to the cash for a week before releasing the funds to the public.
Although Beijing is helping banks nationwide, many of these companies are admitting that they cannot keep their heads above water. A recent survey revealed that one-third of banks anticipate a decline in revenue, and 85% say that they are unsure if they will be able to keep their doors open for an additional three months under current conditions. Perhaps they will be given a bailout.
The biggest consequences for these banks are the bad debts and non-performing loans they must continue to hold for the foreseeable future. And this is what could trigger a financial crisis.
Banking on Debt
The epidemic is having a severe impact on businesses, particularly in the Hubei province. Without enough revenues, it is becoming harder for these companies to continue to operate. Since they are not making enough money, it will be more difficult to repay their loans. This has the banking system bracing for the worst-case economic scenario.
Today, China’s banks possess approximately $550 billion in non-performing loans (in default or close to default). Should the coronavirus outbreak extend into the summer, this figure could dramatically spike in the months to come. The S&P recently warned that financial institutions in the epicenter of the virus would witness the biggest jump in problem loans. Last year, the Hubei region had $700 billion in outstanding loans held by 160 banks – local and foreign. Plus, the nation’s five largest banks have been exposed to roughly $400 billion in loans in the area.
Zero Hedge recently pointed out that the four main state-owned lenders control a cumulative $14 trillion in assets and trade at a record-low average of 0.6 times their forecast book value. What does this mean? Put simply, $6 trillion in bank assets are currently worthless.
It is widely expected that the next stimulus move by the PBoC will be to cut, once again, the reserve requirement ratio (RRR). This is the number of reserves that banks are mandated to hold. The central bank has been slashing the RRR for the last 18 months to spur lending, and the last reduction happened at the beginning of January. The problem with this move is that it would decrease the number of reserves that the banks hold, which might prevent them from being able to withstand a bank run.
While bank runs are the last thing on the minds of the Chinese, there have been instances over the last year of various banks throughout the nation reporting runs. They were so bad that the government stepped in and either assured depositors that everything was fine or forced the largest banks to absorb the smaller ones. What happens when these institutions lend out and “tolerate” bad loans for an extended period and then are unable to meet withdrawals?
Fan Yifei, a vice governor at the PBoC, did say in a statement: “We will support qualified firms so that they can resume work and production as soon as possible, helping maintain stable operations of the economy and minimizing the epidemic’s impact.” But this has been the de facto policy since the country began reporting a slowdown in growth.
How much longer can Beijing bail out everyone and keep the Ponzi scheme going?
No Yuan Left
Debt has been instrumental in both growing and sustaining China’s financial sector. The latest Institute for International Finance (IIF) figures show that the debt-to-GDP ratio for the industry has topped 300%, which is higher than the government and consumer ratios, 250% and 175%, respectively. With fewer borrowers being allowed to postpone repayments and more banks being prevented from calling in debts – good and bad – these entities will be hanging on by the seams of their pants. And, unfortunately, those pant pockets are filled only with lint and perhaps flasks of baijiu.
Read more from Andrew Moran.