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Sunday, February 12, 2012 11:59 AM

China Instructs Banks to Roll Over $1.7 Trillion in Debt to Avoid Mass Default

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A few years ago local Chinese municipalities had little debt. Today they have a $1.7 trillion mountain of it, nearly all of it financing economically non-viable projects in the name of "stimulus".

The proposed "solution" of course is to roll the debt over, while adding still more to the debt mountain, hoping things will get better.

Please consider China tells banks to roll over loans

China’s stimulus response to the global financial crisis saddled its provinces and cities with Rmb10.7tn ($1.7tn) in debts – about a quarter of the country’s GDP – and more than half those loans are scheduled to come due over the next three years.

Since the principal on many of the loans is not repayable, banks have started extending maturities for local governments to avoid a wave of defaults, bankers and analysts familiar with the matter told the Financial Times. One person briefed on the plan said in some cases the maturities would be extended by as much as four years.
Extending Maturities to Avoid Default

A few more details emerge in China extends loans to avoid mass default
A mountain of debt is coming due and the principal is unpayable, so governments have agreed to extend maturities. This could be a description of a bail-out package for Greece. Instead, it is what China is doing to prevent scores of provinces and cities from defaulting on bank loans.

The flaws in China’s fiscal system were savagely exposed during the global financial crisis when Beijing introduced a stimulus package that was largely implemented by local governments.

Lacking sufficient funding and prohibited from even borrowing money because of past excesses, provinces and cities created thousands of financing vehicles to get around the rules and raise capital in the quickest way possible. They tapped state-owned banks which, encouraged by Beijing, were happy to oblige with enormous loans.

From relatively little debt at the start of 2008, local governments finished 2010 owing Rmb10.7tn ($1.7tn). The national auditor has reported that more than a third of that debt will have matured by the end of this year.

“We are not talking about a cash flow problem. We are talking about a big cash shortfall problem,” said Zhu Ning, deputy director of the Shanghai Advanced Institute of Finance.

Critics have pointed to dangers in the loan rollover plan. Repayment delays will hinder banks’ lending abilities. Some bad loans will simply be prolonged instead of recognized. Problems will remain concealed.

Standard & Poor’s has warned the extension would be a “backward step” for the Chinese banking sector that could “shake investors’ confidence”.
Eventually China Will Print to Cover the Losses

Most of these loans will never be paid back. Eventually China will just print money to make the banks solvent.

For more on the folly of loans to State Owned Enterprises (SOEs) from a Michael Pettis email, please see China Financial Markets: When Will China Emerge From the Global Crisis?

Pettis is working on getting his site back up at another service provider. The outage may be provider related rather than state related as I first suspected.

Mike "Mish" Shedlock
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