The Woo Group RBC Wealth Management Tokyo on China’s Looming Debt Bomb

China’s looming debt bomb: Shadow banking and the threat to growth

Caofeidian lies a three-hour drive east of Beijing, a Chinese industrial dream jutting into the sea. A decade ago, it was a pretty coast whose shallow waters were dotted with fishing vessels. Today, it’s a manufacturer’s paradise in the making, its eight-lane roads connecting sprawling factories to a vast port. Named after a former imperial concubine, it was a place of feverish fantasy, where borrowed money fuelled a vast reclamation effort to create 200 square kilometres of land and build something new.

When former Chinese president Hu Jintao came here in 2006, he called it a “treasure of a location” and likened it to “a piece of white paper, and the best and newest pictures ought to be drawn on it.”

What he likely did not envision: a giant money pit, half of whose debt seems unlikely to be paid back.

Caofeidian was to be home to a million-person eco-city, a massive steel factory, a power plant, an oil refinery and a panoply of apartments, bus makers, warehouses, lumber plants, a Sino-Japanese business park, even an “exhibition centre of strategic new industries.” A decade of spending poured $100-billion into the soil here, the equivalent of the annual budgets of British Columbia, Alberta, Manitoba and Saskatchewan combined.

But the loans that allowed all that spending have just 50 per cent odds of being paid back, says an independent research group that has spent years studying Caofeidian. The stakes are enormous. Caofeidian was a project of national importance for China, a “flagship,” according to Jon Chan Kung, chief researcher at Anbound, a Beijing think tank.

“If this project fails, it proves that the major model driving China’s development has also failed,” he says.

Debt now stands to undo at least some of what China’s spending has accomplished. Some of the country’s major projects have done little more than strand vast amounts of invested capital. Debt is just one of the ticking time bombs in China today. China must also cope with the fallout from slowing spending in a place where social stability has been largely defined by one thing: the non-stop accumulation of wealth.

“There will be a financial crisis. And I feel that the financial crisis is in the near term,” says Anne Stevenson Yang, co-founder of Beijing-based J Capital Research. “There will be a recession and then a long period of very, very slow growth. That’s my definition of collapse. I’m not talking about people running through the streets with torches. That may or may not happen.”

China has, for years now, become the engine of global growth. Its building sprees have kept afloat thousands of mines, its consumers have poured billions into the pockets of car manufacturers around the world, and its flush state-owned enterprises (SOEs) have become de facto bankers for energy, agricultural and other development in just about every country. China holds more U.S. Treasuries than any other nation outside the U.S. itself. It uses 46 per cent of the world’s steel and 47 per cent of the world’s copper. By 2010, its import- and export-oriented banks had surpassed the World Bank in lending to developed countries. In 2013, Chinese companies made $90-billion (U.S.) in non-financial overseas investments.  Continue reading…

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