China’s Credit Guarantee Funds and risk
China is pursuing two contradictory goals simultaneously. One calls for throttling back credit to risky parts of the financial system. The second is the creation of a default mechanism for ailing companies that in some cases includes state assistance. The policies are designed to continue to inject credit into the economy while providing a “backstop” mechanism to prevent financial contagion. Credit flows, credit risk, and debt workouts can, in theory, work together. But in China, they tend to be in conflict. Whether this works depends on how it is implemented. The devil is in the details, and the details suggests the government is once again “side-stepping” the problem of bad debt.
Two statements were issued recently that exemplify this contradiction. One was a statement by the Politburo calling for a renewed fight against financial risk in the economy. The second was the recent establishment of a credit guarantee fund in Henan Province and plans for many more across China.
According to the South China Morning Post, the Politburo said fiscal policy would focus on solidifying grass-roots operations and optimizing the structure of the economy. The central bank would maintain reasonably ample liquidity in the financial system, strengthen support for the real economy, particularly in key sectors and vulnerable areas, and maintain the basic stability of the yuan exchange rate. “We must promote domestic demand, manufacturing and private investment to recover as quickly as possible … and ensure domestic demand expands with the rise in people’s income,” it said. Also, the Ministry of Commerce will launch a month-long promotional campaign to boost consumer spending.
But the statement goes on to add the crucial wrinkle: “To better deal with the country’s financial risks – including weak liquidity at many small banks and mounting debt repayment pressures on some local governments – the central government plans to build a bad debt disposal mechanism that will be largely the responsibility of local Communist Party and government officials.”
Promoting growth and tackling risks often work at cross-purposes in China. But to then push the bad debt workouts to local governments, already mired in debt and struggling, is not a policy but a wish. We look at how all this might work.
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