Via the WSJ:
By Alex Frangos
Updated Feb. 29, 2016 5:40 a.m. ET
China still has room to cut, but it may not be having much effect other than hiding the economy’s pain.
The People’s Bank of China waited until the Group of 20 financial bigwigs were safely out of Shanghai to resume its easing campaign Monday, cutting the reserves banks are required to hold with the central bank by half a percentage point. As moves go, it is pretty standard and expected given China’s sluggish economy.
The cut follows up on what has looked like a strong start to lending this year, something that has provided a palpable sense of relief in some markets.
In reality, more credit in China isn’t all that stimulative. A concerted lending boom in theory could jump-start growth as it did in 2009 in the aftermath of the global financial crisis. Iron ore prices, for instance, have rallied sharply on expectations of renewed Chinese demand.
The problem is that China has reached an inflection point. A substantial chunk of new debt is increasingly going to pay old debt, creating less activity in the real economy aside from bankers’ fees and commissions. Like a patient with a headache who has already taken aspirin, more medicine won’t dull the pain much, but it may lead to complications.
A measurable effect is the so-called evergreening of credit, where lenders essentially roll loan maturities or provide credit simply to pay off old debt. Deutsche Bank measures this by estimating what’s owed each year by companies in terms of principal payments and interest expenses. It then assesses the resources to make those payments, namely operating cash flow, freshly raised equity and excess cash not earmarked for general expenses like salaries.
The result is a massive shortfall in the debt service compared with the sources of cash, to the tune of about 10% of corporate debt last year. That gap is filled with more borrowing. Five years ago, Chinese companies were generating excess cash to pay off debts, so new debt could be used to invest.
The most egregious evergreeners are state-owned companies in industries with massive overcapacity issues. Coal mining and metals, for instance, account for 30% of evergreening, according to Deutsche.
What could alleviate the evergreening problem? A positive step would be to allow companies in those problem sectors to enter painful restructuring. This would at least remove a source of demand for evergreening loans.
A concerted effort by the central government to clean up the banking system could also help. This would have to go beyond sweeping problems under the rug. For instance, a local government bond swap program launched last year provides relief to borrowers, but much of the money goes to evergreening, since the increased credit isn’t necessarily being spent.
Recapitalizing the banking system through equity injections and removal of evergreen loans out of the banks and onto the central government’s balance sheet would release the banks from having to constantly generate evergreen loans for the most troubled borrowers. Freed of that burden, banks could channel credit to private borrowers in productive sectors who might actually spend the money rather than use it to pay off old debts.
For now, however, China just seems to be piling up new debts on top of old ones, without cleaning up the mess. That may prevent defaults within the banking system, but it does little to get the economy going.
Write to Alex Frangos at firstname.lastname@example.org