Commentary: China Mobile homemade-tech risks offer case in point
The Chinese economy found a new gear in the last quarter of 2012, as growth re-accelerated. But corporate China could find it harder to get an earnings lift from this burst of activity.
One recurring fear is that companies, particularly in state-owned industries, are adding capacity they do not need. While this can help support GDP numbers, it often results in excess capacity, which erodes profitability.
After the pick-up in fixed-asset investment at the end of last year, overcapacity fears resurfaced once again. Industries such as solar power and glass-making have twice as much capacity as needed, according to recent reports.
These concerns have analysts combing through coverage as we approach earnings season to flag any unwelcome negative earnings surprises.
UBS says in a new report that industrial overcapacity has put serious downward pressure on margins over the past two years.
Nouriel Roubini: China has had to rely on another round of monetary, fiscal, and credit stimulus to prop up an unbalanced and unsustainable growth…
…China has had to rely on another round of monetary, fiscal, and credit stimulus to prop up an unbalanced and unsustainable growth model based on excessive exports and fixed investment, high saving, and low consumption. By the second half of the year, the investment bust in real estate, infrastructure, and industrial capacity will accelerate. And, because the country’s new leadership—which is conservative, gradualist, and consensus-driven—is unlikely to speed up implementation of reforms needed to increase household income and reduce precautionary saving, consumption as a share of GDP will not rise fast enough to compensate. So the risk of a hard landing will rise by the end of this year.
In a new report, GMO’s Edward Chancellor and Mike Monnelly warn of “acute fragility” in China’s financial system, and write, “the public appearance is of a banking system with negligible levels of bad debts, ample liquidity, and low leverage. The reality, on closer inspection, looks rather different”.
China has created too much credit too quickly.
The last big surge of credit came in 2009 when China unleashed 4 trillion yuan to help spur economic growth and employment.
“Since that date, China’s economy has become a credit junkie, requiring increasing amounts of debt to generate the same unit of growth. Between 2007 and 2012, the ratio of credit to GDP climbed to more than 190%, an increase of 60 percentage points.” In 2012, new credit to the non-financial sector totaled 15.5 trillion, that’s equivalent to 33 percent of 2011 GDP.
China also has significantly more debt than its emerging market peers.
A lot of debt is sustained by real estate which is offered as collateral, and credit booms end when property bubbles burst.
“Recent research suggests that credit booms are more likely to end in severe busts when they coincide with property bubbles.”
A lot of China’s debt is supported by real estate which is put up as collateral for the loans. Banks’ official exposure to property is listed as 22 percent of the loan book. But that doesn’t account for exposure to real estate through their loans to local government financing vehicles (LGFVs) and off-balance sheet credit instruments.
Sudden drops in real estate prices caused a jump in debt problems and non-performing loans.
“What is your warning and what do we do about it?” asked the CNBC hostess.
“Well, I think first of all, investors must realize that the impact of a slowdown in the Chinese economy, which in my view is much larger than what the government has been reporting,” Faber responded.
“The [Chinese] government says GDP [Gross Domestic Product] has been growing at 7.8 percent. In my view, it’s much lower because we have very reliable statistics, say, export figures from Taiwan, export figures from South Korea. Where the largest export destination is China, they’re down year on year. Electricity consumption in China is hardly growing and so I think the economy in China is rather weak,” he added.
But why did stocks rally last Friday when these less-than-stellar reports on China’s economy were released?
“[T]he markets have rallied because they think that because of weak economic growth in China, they will stimulate, they will print money like in the United States and Europe and — it will boost prices for a while,” Faber explained.
Watch Faber explain his prediction [via CNBC]: