In its Quarterly Report published in December 2014 The Bank of International Settlements expressed its concerns about the amount of off-shore lending in US Dollars, which could pose a risk to global financial stability. The bank also had particular concerns about recent developments in China, where US Dollar loans to Chinese banks and companies were rising at 47% p.a.
The BIS said that: “China again dominated inflows to EMEs [emerging market economies]. Cross-border claims on the country increased by $65 billion during Q2 2014 and were up by 47% in the year to end-June 2014. Owing to such rapid growth, China has become by far the largest EME borrower for BIS reporting banks. Outstanding cross-border claims on residents of China totalled $1.1 trillion at end-June 2014, compared with $311 billion on Brazil and slightly more than $200 billion each on India and Korea.” The BIS added that, “A key factor behind the surge was transactions between mainland and overseas offices of Chinese banks. Yet even on a consolidated basis – that is, after excluding inter-office transactions – and taking account of foreign banks’ claims booked via their affiliates in China, BIS reporting banks’ exposure to China was almost twice as large as that to any other emerging market economy. At end-June 2014, it stood at $813 billion, compared with $456 billion vis-à-vis Brazil and $381 billion vis-à-vis Mexico (for consolidated foreign claims on an ultimate risk basis). As recently as 2009, China was not even among BIS reporting banks’ top five foreign EME exposures.” China has seen a remarkable change since the 2008 Financial Crisis, the BIS says that “China’s share of BIS reporting banks’ foreign claims on all EMEs has grown from 5% at end-2008 to 16% at mid-2014. During the same period, China’s share in foreign claims on emerging Asia has risen from 17% to 38%.”
If the primary driver behind China’s rapidly growing indebtedness is intra-company transactions, this is a symptom of the growing internal pressures within the Chinese economy as the country slows down and attempts to reverse it’s extremely high investments rates (which has at times reached 50% of GNP). Michael Pettis has said that he assumes, “that one of the consequences of an economic slowdown in China will be a surge in potential insolvency among the smaller banks, a large part of which are probably already insolvent but kept liquid by confidence in the banking system.” If that logic is followed then the activity identified by the BIS may be evidence of a vast Ponzi scheme, where insolvent organizations, having borrowed before the 2008 Financial Crisis, are now being forced to refinance non-performing loans.
Virtually all Chinese inflows are organized by offshore companies, and as the BIS says, “the risk profile of offshore debt is likely to be very different depending on whether the issuing affiliate is a fully fledged firm with significant operations in the country of residence or if it is merely a conduit channelling funds to the parent.”
These developments are taking place in what the BIS refers to as, “an environment of growing uncertainty about the global economic outlook and increasing geopolitical tensions.”
As the IMF stated in October 2014 (The World Economic Outlook): “The world economy is in the middle of a balancing act. On the one hand countries must address the legacies of the global financial crisis, ranging from debt overhangs to high unemployment. On the other, they face a cloudy future. Potential growth rates are being revised downward, and these worsened prospects are in turn affecting confidence, demand, and growth today. The interplay of these two forces—the crisis legacies proving tougher to resolve than expected and potential growth turning lower—has resulted in several downward revisions to the forecast during the past three years. The forecast in this edition of the World Economic Outlook is, unfortunately, no exception. World growth is mediocre and a bit worse than forecast in July. At the same time, because these two forces operate to different degrees in various countries, the evolution of the global economy has become more differentiated.”
In other words we are in a period of great uncertainty, the outlook does not look good, but there are no certainties as to future developments. However, the rapid growth of Chinese offshore loans may indicate that the situation within China is worse than feared.
© Andrew Palmer, 2014