China Threatened by Bad Debts

Moody's warned that Japanese Banks were exposed to problematic loans, particularly to local governments.

Amiel Ungar , | updated: 11:38 PM

Chinese Fast Trains
Chinese Fast Trains

Moody's lobbed a financial hand grenade into the global markets by predicting that between 8% to 12% of the loans extended by Chinese banks would eventually be nonperforming. This means that the borrower would not be able to repay back the loan.

According to the investment service the amount on loan to local governments exceeds the official audit figure by $540 billion. In response to the negative assessment, share prices for Chinese banks declined, but that is the minor part of the story.

As both the United States and Western Europe flounder amidst debt crises, China was considered a pillar of stability. If the Chinese banks are exposed to local government borrowers China's banks could face a debt crisis. These loans would ultimately have to be assumed by the central government precisely when the Chinese government is attempting to rein in inflation.

Additionally, the banks have extended loans to infrastructure companies for costly projects such as the Yunnan highway extending thousands of kilometers in mountainous terrain to the border with Laos, Burma and Vietnam. Some of these companies are having problems making repayments because the profit expectations have not panned out or the costs have far exceeded initial estimates.

China's 1100 universities have racked up nearly $41 billion in debt.

Some analysts in the government-controlled press are trying to sound a reassuring note, as in the  Standard:

"It's the first time the estimate has been published, giving an idea of how deep the problem is. Once a problem is understood, it would be possible to solve… The message is clear. The central government is on top of the situation.

"It would be worrisome if all debts incurred by local governments are invested in the property bubble. However, a lot of the money is invested in important infrastructure such as the high-speed railway."

The word infrastructure is occasionally employed as a cost immune to economic fluctuations and reverses. The assumption is that an investment in infrastructure will always pay for itself.

That proposition is debatable, as one can see from the opposition to the Obama administration's proposal for the high-speed rail. The best example is Japan. Japan invested billions in high-speed bullet trains and massive road networks to connect the remotest parts of the country to the center. While this undoubtedly helped the periphery as well as politicians and construction companies, it saddled Japan to this day within an enormous internal debt that has drained resources from more needed projects.

If the Chinese government is going to have to absorb the losses from white dragons, it will not have the available resources to invest in projects that it considers crucial. such as low-cost housing.

China's colossal economic achievements since it emerged from self-imposed isolation in the late 1970s have sometimes created the impression that the Chinese can do no wrong economically.

China's Western admirers sometimes fall into the same trap as the Maoists who believed that sheer size and political willpower could overcome economic reality.