My Blog

July 18, 2008

The stock market raced up today, with the SSE Composite closing at 2778, 3.49% higher than yesterday’s close.  Since investors are still digesting yesterday’s mix of good news and bad news – GDP slowing, fixed asset investment soaring, CPI down, PPI up – I suspect the main cause of the decline may have been the decline in oil prices to $130 a barrel.

Cui Enze, one of my Peking University students currently completing a summer internship at Van Eck in New York, was nice enough to sleuth out the CPI numbers for me on the National Bureau of Statistics of China website.  According to him, this is the breakdown of the food and non-food components of CPI:

Without the actual index numbers, it is hard to extract much information from this series except to note the obvious – that non-food inflation is low but rising.  If I make a simplifying assumption that non-food inflation last year ranged from zero to 1%, it implies that non-food inflation year to date is probably running at an annualized pace of 2-3/4% to 3-3/4%.  This is not particularly high in itself, but remember that these numbers are being held down by price controls and, more importantly, that if Chinese monetary policy were consistent with low inflation, the surge in food prices should have caused at least some deflation in non-food prices.

Enze also sent me a separate note in which he alerted me to an article in this week’s Caijing

Just read news on the Caijing website that the CEO of a big private company (GoldenSun) in Yi Wu of Zhejiang province disappeared the other day.  The reason is that this company has 1.4 billion RMB outstanding debt which was borrowed through informal banks. Of the 1.4 billion, 800 million is principal and 600 million is interest not paid. The asset of this company has been audited or sold to repay part of debt.

This company had been borrowing through informal banks at an interest rate of only 2%-3% in 2005, but ever since late 2007, the interest rate has climbed as high as 12%, which brings a huge cash flow pressure to the private companies in Zhejiang. This year, several other owners of private companies in Yi Wu have fled because they can't repay the high interest.  As most of the small companies in Zhejiang are export companies, the RMB appreciation and rising price of raw materials have significantly reduced their profit margin.

I checked the English version of Caijing and saw the story, although it didn’t have as much information as the Chinese version which Enze cites.  It did say the following:

A source told Caijing that Zhang raised money through a local version of China’s informal “gao li dai” credit system, which lets private individuals lend cash at high interest rates to persons or companies through go-betweens known as “hui tou.”  The system flourishes thanks to legal loopholes.  In Zhang’s case, the hui tou allegedly included local officials and lawyers. Many lenders mortgaged homes to raise the money that Zhang borrowed over the past two years, the source said.

The article closes by quoting a Yiwu-area banker as saying: “More bosses will flee later this year.”  I suspect that these sorts of stories are going to become more common.

For now I don’t know how common these sorts of defaults are likely to be, but at least this article does address one question that comes up a lot.  I have often heard people assert that the informal banking system is not a significant source of banking risk because loans are too small to matter, even in the case of serial default.  But this story involves loans from the informal sector of significantly more than $100 million to one client.  This sounds like regular banking to me.

Another student, who wants to remain anonymous for obvious reasons, also sent me an interesting note today (it’s great to have such great students).  He is spending the summer as an intern at one of the larger and better city commercial banks in the southeast.  He tells me (with some editing on my part, largely to hide names):

We saw some weird stuff yesterday in the money market.  If you only looked at the money rate, it was a normal day, but in the real market, a Big Four bank unexpectedly ran out of liquidity, and they were asking for money eagerly from other banks.  Because this bank is a major money-provider in the market, small or city banks like us cannot lend them money at a very high rate (because of their power and "mianzi").  We worry that they may punish us later when we lack money ourselves, so most of us choose to say: "Sorry, but we also lack money."

It wasn’t until 3:30 in the afternoon, that the bank finally got the money it needed, but because of their lack of money, small banks also could not borrow.  Our bank was also caught in this trap and not able to borrow one cent before 3:30.

My student goes on to tell me that his money market traders told him that these sorts of liquidity squeezes have become increasingly common during this quarter.  I haven’t been able fully to figure out what this means.  It may simply be the expected consequence of the several hikes in minimum reserve requirements.  If so, this puts a little hair on the statement I cited yesterday by a banking regulator who warned that further reserve hikes were hurting the system. 

I wonder if anyone else among my readers saw something similar and can explain what happened or how common it is.  One of the few things I learned from my banking classes at Columbia Business School (and amply confirmed in my many years as a bond trader) is that problems in the banking system usually first turn up in the plumbing – the otherwise very unglamorous  money markets.  I always tell my finance students to keep an eye on the money markets, and I am glad to see that at least one of them has taken me seriously.

Comments (11) for "Tightness in the money market?"

Michael, it is my understanding that real estate market policies have been tight since the third quarter 2007 to limit growth. This article says, regulators started curbing credit lines for real estate companies. http://www.caijing.com.cn/20080714/74558.shtml "Housing sales in China have seen nation-wide drops since January. Forced by a tight capital chain and government credit control, developers began to lower their prices hoping to boost sales. According to the National Statistics Bureau, Beijing has witnessed slowing growth in housing prices since the beginning of the year. In May, housing prices in Beijing rose 12.4 percent year-on-year, which is 0.6 percent lower than the growth rate in April. Statistics show that Beijing’s property market has been oversupplied for the first time since 2005. New additional housing space added to the market amounted to five million square meters, while sales have reached 3.5 million square meters in the first five months. DTZ said the recent sluggish performance of property market is a short-term response to the government’s controlling measures implemented on the industry. China will raise the deposit reserve ratio to 20 percent by the end of 2008, if DTZ predictions are correct. Bank loans in the property industry will also fall 300 billion yuan from last year’s sum to 880 billion yuan this year, said DTZ’s Jiang Shangli." High growth equals a high need for cash flow. If the market is slowing and credit is tight, real estate developers have to search alternative ways of funding as Victor Shih has described: “Currently, the Wenzhou curb market in which exporters are lending export receipts to desperate real estate developers is paying anywhere from 30% to 100+% in annual interest rates. What is the rational course of action for exporters who obtain easy credit from the official banks? Yes, they would turn around and lend to real estate developers, which actually would continue to boost the supply of housing and depress the market. Although these high interest loans tend to be short-term (less than 90 days), when the music stops and someone defaults, the chain of defaults can ultimately lead back to the state banks.“ http://www.rgemonitor.com/emergingmarkets-monitor/252953/michael_is_right_policy_priority_shifted If a bank is desperate for liquidity, there are almost always non performing loans in the books. And on a second though: Is it possible that the wave of hot money inflow this year is not a cause of the problem, but an effect? By Gregor Neumann - 7/17/2008 8:00 PM

So where is all that hot money flowing into China going ? Something is not making sense, if you have huge inflows and the government is actually trying to mop up it up. Are there plans actually working ? As for non-food inflation, again the numbers make no sense - way too low. Minimum wages as well as income figures are huge in the double digit range, w/ labor the main component of costs, its hard to see how inflation can be so low. Seems like service costs should be up 15% at least. On the manufacturing side, its also hard to see goods inflation so slow given both wages and raw inputs costs up hugely. Is productivity that high to offset the wage increase and/or profit margins taking a big hit. Obviously w/ exporters(note that volumes are up, so it not from lower sales) many of them are taking the hit - but that is just more evidence that inflation in the non-food sector must be much higher than the official numbers. By SuperDiesel - 7/17/2008 11:06 PM

My observation is that non-food inflation seems to lack a reasonable level of volatility. Is it reasonable to expect that the series should not change by more than ten basis points in any given month? Imagine how entrenched inflation trends must be to produce such an outcome. I would say this is true of most government inflation stats, including the U.S. One explanation is that, while we expect a broader dispersion of price increases and decreases, the net effect is a steady weighted average. Still it could also point to "smoothing" of the numbers by government statistical offices. By David Pearson - 7/18/2008 12:25 AM

First I'd like to thank you for the personal reply on my question of the 'one child per family policy'. And I'd like to say that the above article is very interesting to me. I am particularly curious about the real small time issues and local color. The student's input is fascinating. Thanks again... jegan By John B. Egan - 7/19/2008 1:17 AM

In most countries housing costs make up some 30% of CPI. Could someone expalain what the housing market in China looks like for ordinary people. Do people own or rent? Do they rent private flats, or only public? How does the mortgage lending work, what are the interests? I would guess that housing costs have risen quite a lot. But are all those costs, e.g the rents, regulated? By Stefan, Tallinn - 7/19/2008 2:51 AM

"Big Four bank unexpectedly ran out of liquidity" could be true, but no need worry. There are some other channels to raise capital. Such as the Bank of Comminication is offerring RMB debt without securty in Hong Kong. The Senior officer of Money Authority of Hong Kong said the door is open in Hong Kong or other banks in mainland to issue RMB debt in HK. The interest rate for one- year debt is 3.25%. There are quite lot of people keen in buying this kind of finance product. By taolower - 7/20/2008 2:41 PM

SuperDiesel: Is productivity that high to offset the wage increase and/or profit margins taking a big hit. A bit of both. My explanation for the figures is that the industrial/banking reforms of the late-1990's increased productivity which cause a massive increase in corporate revenues. Chinese companies have been making huge amounts of money since 2002 and that money has gone into corporate savings. These large earnings gives corporations the ability to absorb increases in wages and raw materials before passing those increases on to consumers. It's not that Chinese productivity is high, it is more the fact that it was abysmally low before, and is now low rather than shockingly low. Stefan: In most countries housing costs make up some 30% of CPI. Could someone expalain what the housing market in China looks like for ordinary people. Do people own or rent? Do they rent private flats, or only public? How does the mortgage lending work, what are the interests? During the 1990's the state turned over title of urban apartments to the people living in them, and this "gift" results in a situation in which most urban dwellers own their apartments outright and pay no rent. This also explains a lot of other characteristics of the Chinese economy such as the high savings rate, and the frothy real estate market. A lot of people buy real estate not to live in but as an investment to put their savings. By Twofish - 7/20/2008 11:24 PM

One important thing to mention about Victor Shih is that he is talking about a hypothetical, and the big state banks generally do not lend to small exporters, especially in Wenzhou. Wenzhou is famous for developing a system of local finance that is quite independent of the state banks. Also the book that Victor Shih has written on monetary policy and factionalism in the Communist Party is quite brilliant, but I where I disagree is that he seems to think that the system that he describes is a bad thing whereas I don't. In particular, one thing that Shih refers to is to low efficiency of Chinese corporations in 1990's, and my view is that the low efficiency was due largely to the companies having social welfare obligations that in another economy would be the responsibility of the test. Since those obligations have been transferred, Chinese corporations have been doing quite well. By Twofish - 7/20/2008 11:35 PM

Twofish Thanks a lot for that information. By Stefan, Tallinn - 7/21/2008 4:11 AM

Maybe I should add a follow up question: Is there any "equity extraction" from these privately owned homes, could that fuel a credit-lead expansion some years ahead? Here in Estonia, soviet-time apartments were similarily distributed to the dwellers. As banking developed a lot got mortgaged, and bank lending balooned. By Stefan, Tallinn - 7/21/2008 4:16 AM

ChinaStakes has an interesting summary of funding problems for smaller companies. Some highlights: “Since the beginning of the year, due to the tight monetary policy, commercial banks have reduced loans to SMEs. State-owned banks have long ignored SMEs, while joint-stock commercial banks have also abandoned many small companies in the first half of the year. This has created a very inhospitable atmosphere for these companies.” “Recently the local government of Zhejiang released Opinions on the Pilot of Small-Sum Loan Companies, in an effort to solve the financing problems faced by SMEs by legitimizing the lending of private funds. Meanwhile, the loan interest rate of small-sum loan companies is basically decided by the market. According to the relevant regulations, it should be no higher than 400% of the bank loan interest of the same kind.” “By the end of June, the bad loan balance of domestic commercial banks totaled 1.24 trillion yuan, 25.92 billion yuan down over the beginning of the year; while the bad loan ratio stood at 5.58%, falling 0.59 percentage point since the beginning of the year. “ http://www.chinastakes.com/story.aspx?id=538 By Gregor Neumann - 7/22/2008 4:48 AM