China Squeezing Local Govts

Fixed asset investment from state entities tumbled 5.8 percent in July. I haven't seen as much shock about that number as I expected. Granted, the government wants the private economy to grow faster (at least it says that). Local governments and SOEs are the biggest threat to the private economy because they'll get first drink at the credit tap. China also doesn't want another real estate bubble. It says it doesn't want speculative credit in housing. The PBoC and CBIRC say they'll support lending. Maybe the private economy is getting a headstart, first dibs at new credit and in a few months, local governments and SOEs will by unleashed. If not, it is hard to imagine the private economy sans real estate absorbing enough credit to keep the economy going.

The Chinese government is also using carrots and sticks with local governments. On the one hand, its rushing 1 trillion in special-purpose bonds over the next four months.

On the other...

SCMP: Low-hanging fruit and a mountain of debt – how China’s credit binge is playing out

Now, the vineyard sits at the centre of a “new town” covering an area of 27 sq km (10.4 square miles). A 3.3 billion yuan (US$481.8 million) hospital has just opened there, an imposing city hall will follow, and on a recent visit by the South China Morning Post, workers were installing curtain walls on two high-rise buildings that will be the headquarters of the city government’s biggest fundraising vehicle, Changde Caixin Financial Holding Group.

“This is totally beyond my imagination – the whole area developed very quickly after several new main roads were built,” said Ma, a 44-year-old father of two. “But construction of many government projects has really slowed down recently. It seems they’re suddenly running out of money.”

...It is one of hundreds, if not thousands, of Chinese cities trying to take a bigger place in the country’s economic landscape. But like many others, its ambitious development blueprints and countless infrastructure projects go well beyond what the government can afford. Changde’s fiscal income of 16 billion yuan last year covered just a quarter of its spending – the rest came from Beijing and Changsha.

...The mid-sized city made headlines in June when a memo from a meeting between government officials and local bank branches was leaked. According to the memo dated June 22, the Changde officials asked the banks to roll over all loans to financing vehicles to the local government and its affiliated vehicles from July, and to lower their interest rate to the benchmark of 4.35 per cent a year.
See: History Repeats: Chinese City Tells Banks to Lend To City LGFV or Else

Back to the SCMP story:
A local private equity professional who is involved in raising money to fund government projects said “Changde did nothing different from hundreds of other Chinese cities” through its borrowing.

The financing vehicles did a pretty good job of shoring up the local economy, improving urban infrastructure and controlling debt,” said the person, who declined to be named.

...In Changde, it was clear by April that the authorities were under huge pressure to start repaying debts. City officials called a meeting of more than 30 financial institutions, telling them the government guarantee for local financing vehicles would be withdrawn in line with Beijing’s orders.

One banker who was in the room said it was not taken seriously by the lenders at the time because that “tacit guarantee” had always been there and all local governments were part of the centralised apparatus, backed by Beijing.

But the banks have become worried since it became apparent that the central government may let some local vehicles go bust.

...One of the first to start offloading assets is Changde Economic Development and Investment Group, which has instructed agents to sell properties including stores at two tourism sites – Hejie, or River Street, and “Little Hanover”, a new area inspired by the German city.
Lots of China bulls think Chinese officials are smarter than their Western counterparts. Let's assume its true. They know QE is failed policy. Stimulating the economy and blowing bigger credit bubbles will put them right back into a larger crisis in 3 years. The smart thing to do is break the cycle. Stop borrowing. Stop building simply for the sake of GDP. Let debts default. Have a recession. It's the only way to shake excesses out of the system.

I still believe China will err on the side of inflation and currency depreciation because that's the lesser evil from a political standpoint. Yet whether by inflation or deflation, the impact on the global economy and emerging markets will be bearish.

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