Friday, November 14, 2008

Dear All, my latest post for Roubini's RGE Monitor

A Tour of the Stimulus Package and Beyond
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Victor Shih | Nov 13, 2008

A lot has been said about the 4 trillion RMB "stimulus package" already. As a China specialist, I will just go over some details on how it is likely to be carried out and its implications.

First, a brief primer about state directed investment in China, the core of the forthcoming package. Usually, the central government sets a ceiling on large fixed asset investment projects. If a local government wants to build a port somewhere, even if it is doing so entirely with its own money, it has to receive National Development and Reform Commission (NDRC) permission to do so. If it is a state sponsored project, which means it is part of the five-year plan (yes, those still exist), a project can lobby the NDRC for central funding. However, even if that were the case, the majority of the financing typically comes from local government (or SOE) self-raised capital and bank loans. Thus, the 4 trillion is not all central government money; the majority will come from local budget and bank loans.

Traditionally, such government project financing benefits rich localities which are more able to put up part of the financing. The NDRC would like to approve as many projects as possible, especially now due to political pressure from the top, so they like localities with clear plans and a large chunk of the financing. Thus, a lot of the central money will be distributed to coastal areas and provincial capitals. It is possible that due to the tight cash situation of many local governments, the share of central money would increase in this round. Regardless, bank loans will be a large part of it, and the removal of credit ceiling makes sense in this case. Typically, once a project receives the NDRC's seal of approval, banks are more than happy to lend since it basically receives a government loan guarantee. That has caused some NPL problems in the past, and will likely cause problems in the future.

On to other issues. There is a rumor that Chinese Academy of Social Sciences, a government think-tank, came up with a plan to set up a government fund to buy up Chinese stocks if the market falters drastically. The argument is that since the total market capitalization is only like 930 billion RMB, a fund of 6-800 billion can "save" the market. I think this suggestion is quite problematic. First, it would of course reverse decades of reform, which aimed at making firms more responsible for their own well-being. If the state buys up shares, large firms will simply revert back to state owned enterprises (well of course the US now has plenty of those as well....). Second, if the stock market is allowed to continue, then it will operate under the sword of Domicles as participants wonder when the government will sell the shares back to the public. That was the situation for a long time in China due to legal-persons shares and was the source of a prolonged bear market. Finally, the largest companies are also listed in Hong Kong and New York. Would the Chinese government mobilize CIC to buy in those markets?? What a way to spend one's foreign exchange reserve! In any event, I don't think there will be enough political will to carry this out due to potential charges that this is used only to bail out the rich, which runs counter to Hu Jintao and Wen Jiabao's populist agenda.

In the mean time, the situation in the housing market is only going to get worse since part of the stimulus package seeks to drastically increase the supply of public housing, thus sucking demand away from the lower end of the private housng market. On top of that, slowing export is finally hitting the banking system. The vice head of the Guangdong CBRC recently revealed that loans in Guangdong to the textile sector is now nearly 30% NPL. With the global slow-down continuing, the situation is only going to get worse in places like Guangdong, Fujian and Zhejiang. Fourth quarter may still look okay, but I think we will see some interesting data for 1Q next year.

More likely the sword of Damocles?
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