The first quarter GDP reported yesterday showed a 4.5% growth, surpassing the anticipated 4%. This is already very good at such a time when people were just freed: no need to wear masks for covid anymore. In line with this positive news, the profits of Maotai, the renowned liquor brand (NO.1 market cap in A-share market), reached record high. However, the Guizhou province, where Maotai is based, publicly announced its inability to repay its debts, admitting to its financial struggles. While many provinces and cities are in a similar situation, Guizhou has been the most candid about its predicament.
Link:
The original statement from Guizhou titled "Facing Extreme Difficulties in Debt Resolution, No Means Left for Repayment" is no longer available to read. Easy to guess the reason huh?
Although local debt defaults are not unusual, the timing of this news is intriguing. It comes just as Maotai has announced its annual report, boasting revenues nearing 600 billion with a growth rate of almost 20%. The essence of the announcement is saying “please help me” to the central government, hinting that mere financial aid won't suffice.
Last year's data showed that, according to the central bank, the explicit debt (debt on book) - government bonds - of Guizhou totalled 1.2 trillion. This, compared to the national bond total of 60 trillion and a local debt balance of 34.6 trillion, might seem insignificant. However, the real concern lies in the message it sends - Guizhou doesn’t even want to hide its predicament: it is betting on the central government intervening.
My views are:
- The central government will definitely step in. Local debt has become the second largest obstacle after real estate. If not addressed properly, a significant crisis might erupt, endangering local government’s financing will definitely cause widespread default (game theory result between one leader and many subordinates). This would severely undermine financial stability, which remains a top priority for leadership.
- A financial collapse would inevitably affect the intertwined banking system, with local banks (which effectively act as ATMs for local governments) crashing first, potentially leading to a breakdown of the major national banks. Time could potentially be the best remedy. (As I mentioned before, where has the M2 money gone?)
- Nearly all financial and trust products would default in the event of a collapse. Especially now, as these financial assets are more intertwined with local debt than ever before. (Since crisis began to appear, banks put a lot of efforts to sell new financial products, and those products are very complexly intertwined, and local debt could be found in many of such funds. The leaders never want to see a huge wave of redemptions, because if so the price of all assets would drop. Indeed it’s ALL assets, because for the vast financial products in China, no one is clear about the underlying asset)
- A collapse would result in a loss of confidence, making monetary easing policies ineffective, leading to a vicious cycle.
- Guizhou is forcing the central government to come up with more advanced methods to rescue it. Under the broader context of economic recovery and setting hard boundaries (like the three red lines), it's a tough decision for the central government. I believe the central government will definitely intervene (update in June, a series of helps were offered), as economic recovery is more important than short-term financial gains. With a good economy, continuous financial benefits can be reaped. (By the way, I feel previous leaders were relatively shortsighted, but now, possibly with the lifelong tenure system (Xi), the leadership might prioritize long-term benefits, which might be a good thing.)
- Guizhou choose to play dead at such a time, likely due to their leadership is familiar with the central government's priorities.
Given this, I believe that this year's main strategy will continue to revolve around monetary easing, proactive fiscal policies, or even increasing the local debt.
Traditional central government solutions for such situations include:
- Debt swap with government bonds
- Fiscal funds to help repay or transfer payments
- Borrowing anew to repay the old or deferring payment
- Selling off state-owned assets.
These are merely temporary fixes, with limited funds available.
At this juncture, when looking for a significant source of funds within the confines of a legitimate legal framework, I believe property tax is the only viable option. We might have to further burden the average citizen who's just getting by, especially since the real estate situation is already in its current state.
To conclude with some personal advice on what one should do:
- I believe that the goal of economic recovery remains unchanged. On a micro-level, we must be very vigilant about the power struggle between the central and local governments. Pay close attention to the transfer and promotion of central government officials to local government roles, as well as the focus of the leadership teams in major provinces and cities. For example, there was a case where a central authority directly assigned a head from one of the "Big Four" asset management companies to take over and deal with the non-performing assets of a bank (I remember it was Nanjing Bank). This is a significant signal. Although it's highly unlikely there will be macro-level issues, there might be an increased volatility in the financial market.
- It's essential to firmly reject any high-interest bank financial products. Especially those from local banks, as they are primarily responsible for handling local debts. Do not trust any financial products where you cannot see the underlying assets on paper (though the content on paper still can be false, but at least you have some document to show on court).
- Decline most financial products backed up by local governments, especially those that use government endorsement as a selling point (just consider a loan that extends for 20 years; it's enough to make you cry).
- Lower your economic growth expectations. It's no longer about seeking wealth amidst risks. By lowering your expectations, you find happiness! (quoted from my dear friend Suzy).
On the stock market:
- Be wary of companies that hold a substantial amount of local bank assets or those where the underlying assets are not clear. I'm unsure if the current accounting standards regarding held-to-maturity and short-term financial products have changed, but in 2018, the changes in fair value had to be recorded in current profits and losses. However, if one cannot determine the changes or if the goal is to hold until maturity, then there is a larger room for interpretation. Many assets nowadays, especially those packaged and sold by local banks, don't have a market price. Even though CPAs adopt the "principle of prudence" during audits, the typical approach is to either
- rely on the asset evaluators’ opinion (and it’s common for authority to bribe them) or
- record it as equity. This is because many local public companies are seen as lucrative prospects by local governments, and it's not easy for them to let go.