In addressing a question that was raised by Asher, “how do you think interbank lending and excess local-government borrowing from nonbank lenders interact, and which do you think poses a greater risk to the economy?” I looked up some numbers and what was originally a comment reply turned into a blog post.
To give a general synopsis of the question. Interbank lending has become a concern in China because the rates banks charge other banks has steadily risen evidence that banks distrust each other. At the same time local-government borrowing has reached unprecedented levels with municipalities in the hole for around 3 trillion dollars. Some provinces such as Guizhou has a ratio of debt to GDP of 79%.
I would assume the interaction is that banks are lending at high rates to small businesses drying up the amount of capital in their reserves and limiting the amount they have to lend to other banks. Local governments in competition with one another to fund infrastructure projects have offered high interest rates (8% is a common number) which banks have gobbled up, further reducing the capital at their disposal. With so much of their money tied up in investments banks have to worry over two things namely; default by the municipalities to which they have made loans and keeping sufficient capital in their reserves. With many municipalities running behind on their obligations banks are not receiving money on the schedule that they had planned for. Thus the losses or postponements to their return on investments has put banks at risk for being unable to pay back other banks if something significant effects the markets and causes one of their loans to go bad.
To say that one poses a greater risk to the economy than another misses out on how closely the two are tied together. As competition moves to an all time high and the large amount of economic growth has encouraged more risky ventures banks are susceptible the consequences of risky loans. The failure of several small loans are a few mid-size loans may impair banks to repay larger loans and a chain of defaults can cause a financial crisis. So in that sense their are similarities in the Chinese market now to the conditions right before the collapse in 2008 in the U.S. </p>
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Often when I hear news stories about the United States’ debt there is discussion about how China owns a significant portion of the USA’s debt. I assume that is mostly in the form of US Bonds. Is the Chinese federal government in possession of all the money, if the municipalities are not?
The issue of high debt is one of the major problems that China faces as it’s economy grows up at a fast rate. China is somewhat going through the past that the U.S. went through recently. We will see how the government will react but another problem is that the U.S. also borrowed a lot of money from China. They are all connected. This is not only the Chinese problem anymore. The U.S. must pay careful attention to the problem in China as well.
With China lowering their aims of growth in 2014, this could hinder the exigency China has showed in the past with regards to purchasing our debt. It seems that China previously has relied on the economic well being of the US to purchase their exports but now that they are starting to address the issues domestically rather than focusing on assuaging the problems our economy has faced, they may benefit greatly. It will be interesting to see how 2014 plays out in the far East and how China’s economy will reshape itself, hopefully leading to a valuation of the Yuan.
In 1990 banks in China were still in their infancy, barely able to make loans. Today they still have limited administrative capacity and personnel staffing to be able to lend to small businesses. So what then is the impact of the interbank rate? – it is apparently on semi-governmental borrowers (entities linked to provincial and local governments).
More generally, does monetary policy have an impact in China? If so, is it through an interest rate channel or other mechanisms?
Weak or underdeveloped macroeconomic controls are a pervasive problems in developing countries. This sort of issue is one of the areas that distinguish such economics qualitatively from OECD “developed” economies.
Not to be repetitive to another comment of mine..
One of the big issues is that the local governments (that borrowed at such interest rates for infrastructure that is not seeing the returns they hoped) saw the mass migration (/urbanization) in China (reportedly bigger than any other the world has ever seen), and got excited to put their own horses in the race to take advantage and build up cities to house these people. Unfortunately, despite their high confidence (perhaps why they’d accept high interest rates), many cities are not seeing the results that they had hoped.
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