A Disturbing Question: Where Has All The Money Gone?

Chinese credit growth has outpaced GDP growth for some time.

Some have argued that this is the main bear argument on China right now.

Many are asking why this is the case? Where all the money's gone? And is China facing it's own Minsky moment — a phenomenon that refers to periods of speculation that lead to crisis and that was named after economist Hyman Minsky who wrote about the inherent instability of bull markets.

In a new note, Bank of America's Ting Lu writes that this has raised questions about whether the non-performing loan ratios are higher than expected, if there are more artificially propped up investment projects that are using new credit for interest payments, is there more speculation than people realize

"Property speculation and a rising number of zombie companies," partly explain the credit-GDP growth gap he write. "More careful study tells us that the gap is smaller than what had been believed due to double counting and other distortions, and a majority of the gap could be ascribed to reasonable changes in fundamentals and short-term factors which should not be extrapolated."

From Lu:

"In our view, the 12ppt gap could be decomposed as follows: 2.7ppt due to double counting of funding via non-banking intermediaries; 1.0ppt on FX loans which were used for speculating on RMB/USD appreciation; 0.3ppt on RMB loans used for faking RMB trade settlement; 1.5ppt on zombie companies as a result of bad investment; 3.5ppt on changing fundamentals such as automation, rebalancing and falling returns on FAI; and 3.0ppt on short term factors such as the increased volatility in commodity prices and eased (and cheaper) credit."

Here's a chart that breaks it down easily:



Bank of America


But Societe Generale's Wei Yao is not so optimistic. In a note, excellently summed up by The Financial Times, Yao used methodology from the Bank for International Settlements (BIS) to calculate debt servicing ratio and applied it to China.

Doing that she found, "a shockingly high debt service ratio of 38.6% of GDP, of which 9.2% goes to interest payment (=6.3%×145 % of GDP) and the rest principal. At such a level, no wonder  that credit growth is accelerating without contributing much to real growth!

Yao does think the actual DSR is lower than her calculation but writes that "a non-negligible share of the corporate sector is not able to repay either principal or interest, which qualifies as Ponzi financing in a Minsky framework.

Two slightly different takes on what this means for China?

Lu doesn't see an imminent crisis but does see need for reform. "In our view the central government needs to take more responsibility in infrastructure spending, move some debt burden from local governments to itself, build a functioning municipal bond market, improve prudential regulations, restructure the stock markets to restart IPOs, and make it easier for the private sector to obtain both credit and equity funding.

He also thinks the credit-GDP growth gap will narrow to less than 3 percentage points in two years.

Yao on the other hand writes that this is all still being held together because the state backs both the banking system (not shadow banking), and their support to local governments. "We think this precarious equilibrium could last a bit longer but not much longer, particularly if the central government does nothing."

While this may make investors wary of a hard landing, she writes that it's a good sign that the new leadership is more tolerant of slower growth. She does however expect that we will see more "corporate defaults, rising NPLs, and some degree of credit crunch," in coming years.