Will you pump water in the aqueduct even if you realize it is full of holes? Yes, provided you can afford some waste, the end user is thirsty and the path is not long. Then, once the thirst is quenched, you can fix the holes.
The metaphor refers to Beijing’s plan to rescue local governments whose finances are shaky at best. The China Regulatory Banking Commission (CRBC) and the National Development Reform Commission (NDRC) intend to restructure China’s local debt, sharing again the cost with the banking system. New ad hoc companies will supposedly buy the debt. In 2009 and 2010, commercial banks injected in the system more than $2.700b to underpin domestic demand. Banks are paradoxically easier to control than local governments. Provincial Governments who are financially unbalanced by definition, since they bear 3/4 of national expenditures, but only collect 1/3 of fiscal revenues, used special funding vehicles named “local government financing platforms” guaranteed by public property with little or no cash flow, to borrow from banks.
As expected, these special borrowing vehicles turned up to be opaque, and not surprisingly, unable to return the loans. A $ 400 B bad loan cloud is therefore lingering over the system. The intervention from Beijing and eventual write offs are inevitable.
Losses were predictable. As long as a federal taxation system is not fully in place, local Governments will rely on Beijing’s generosity. Funds are so channeled thru banks in an complicated procedure, difficult to understand from the outside. Local Governments are obviously unable to repay the loans. Beijing has always known these holes are scattered all over. Now the international financial crisis is almost over and the system can be improved. Municipal and provincial governments, for example, will be allowed to issue local bonds. An old ban will be lifted to help funding and transparency.
Overall, this precautionary measure can be seen as a sign of maturity and prudence. If you grow adult and you are healthy, you can absorb the losses that your own policy generate. In fact banks today are solid enough to carry the burden that was much higher at the turn of the century when the Ministry of Finance and the People’s Bank of China had to inject huge sums to recapitalize the banking system and take it to IPO.
There will not be either a financial crisis in China or a bubble to burst. In early 2000, the Government rescued the banking system to launch it in the international arena. We do not think an overhaul of those proportions will be needed this time; current low banks’ share prices have already discounted the recurrent habit of using loans in lieu of deficit financing to then make banks capital share the pain.
Investors who underwrote early IPOs’ have mostly cashed their money and gone. We understand the western financial system needs great fixing in compensation, supervision, ethical behavior, many of us however did hope China would have something more elegant and sophisticated to show.