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Asia Special Report

NOMURA GLOBAL ECONOMICS


NOMURA INTERNATIONAL (HONG KONG) LIMITED

China: Rising risks of financial crisis


China is displaying the same three symptoms that Japan, the US and parts of Europe all showed before suffering financial crises: a rapid build-up of leverage, elevated property prices and a decline in potential growth. We delve into the financial risks facing Chinas economy and find that the most vulnerable areas are local government financing vehicles, property developers, trust companies and credit guarantee companies. We also show how they are interlinked. If the government acts this year with tighter policies and our base case is that it will we believe it can still avoid a systemic financial crisis. But that would come at a short-term cost of slower GDP growth, which we expect to average 7.3% in H2 2013. As history has repeatedly shown, the slower the policy response to financial excesses, the greater the risk of a systemic financial crisis and the more challenging it will be to avoid a hard economic landing.
15 March 2013 Authors Economists, Asia ex-Japan Zhiwei Zhang zhiwei.zhang@nomura.com +852 2536 7433 Wendy Chen wendy.chen@nomura.com +86 21 6193 7237

FX and Rates Strategists, Asia ex-Japan Craig Chan craig.chan@nomura.com See Appendix A-1 +65 6433 6106

for analyst certification, important Prateek Gupta prateek.gupta@nomura.com disclosures and the status of +65 6433 6197 non-US analysts.
Vivek Rajpal vivek.rajpal@nomura.com +91 22 4037 4438

Prateek Gupta prateek.gupta@nomura.com +65 6433 6197 Wee Choon Teo weechoon.teo@nomura.com +65 6433 6107

Nomura

Nomura | Asia Special Report

15 March 2013

Contents
Introduction Symptoms of financial risks 1. Rapid build-up of leverage 2. Rapid asset price inflation 3. Decline of potential growth Identifying the risks Government finances Financial sector conditions Household sector Corporate sector The linkage of risks and moral hazard Endgame: Base case and risk scenario Base case Risk scenario Appendices Appendix 1: Five rounds of trust company regulation Appendix 2: Trust companies have grabbed the headlines Appendix 3: Forecast summary References Recent Asia Special Reports 3 4 4 9 11 15 15 17 21 21 22 23 23 24 26 26 27 28 29 30

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Introduction
The Chinese government has in recent months sent a number of unusually strong signals that it is concerned about financial risks in the economy. At Decembers Central Economic Working Conference, the new generation of leaders stated the need to defend the bottom line of preventing [a] systemic financial crisis. At its Q4 2012 monetary policy committee meeting, the Peoples Bank of China (PBoC) decided to make controlling risks a top policy objective. Then on 31 December, the Ministry of Finance, the National Development and Reform Commission (NDRC), the PBoC and the China Banking Regulatory Commission (CBRC) issued a joint statement on one of the most pressing issues facing Chinas authorities the need to crack down on improper fundraising activities by local governments. The government lowered the M2 growth target to 13% in 2013 from 14% in 2012 at the National Peoples Congress in March. Government concerns have been echoed by warnings from within the financial industry as well as external sources. Bank of China CEO Xiao Gang, writing in the China Daily (12 October 2012, Regulating shadow banking), openly criticised the common bank practice of relying on a non-transparent capital pool to manage wealth-management products and accused them of running a Ponzi game. In its October 2012 Global Financial Stability Report (GFSR) the IMF highlighted Chinas rising financial risks. As we illustrate in this report, there has been a substantial amount of negative news related to new financial products especially trust products and the intensity of such coverage has picked up since late 2012. Nonetheless, we believe the true extent of financial risks in China is not fully appreciated by investors. Fears of a hard landing sent the MSCI China index down to 51.63 in the summer of 2012, but the subsequent economic recovery seems to have alleviated such fears with the index up some 20% since then (Figure 1). The consensus forecast expects a sustainable recovery of GDP growth from 7.8% in 2012 to 8.1% in 2013 and 8.0% in 2014. The market has turned from being very bearish on Chinas outlook six months ago to being quite optimistic. So is the market underestimating the financial risks in China or is the government overalarmed? We believe China faces rising risks of a systemic financial crisis and that the government needs to take action quickly to contain such risks. We assume it will do so in H1 2013 and consequently we expect GDP growth to slow to 7.3% y-o-y in H2 from 8.1% in H1 (Consensus is for growth of around 8% through 2013; Figure 2). If a loose policy stance is maintained and these risks are not brought under control, strong growth of above 8% in 2013 is possible, but that would heighten the risks of high inflation and a financial crisis in 2014. We elaborate our concerns in this report and illustrate them via three common symptoms that have preceded major financial crises elsewhere: 1) high leverage; 2) the rapid rise of asset prices; and 3) a decline of potential growth. Chinas economy already exhibits these symptoms. We discuss financial conditions in the public, financial, corporate and household sectors, and identify the risks that are building for local government financing vehicles, property developers, trust companies and credit guarantee companies. We conclude by laying out our views on the potential triggers that could turn these risks into real threats to the economy.
Fig. 1: MSCI China index
Index 70

The government has sent strong signals that it is concerned about financial risks

The IMF and business leaders have also voiced concerns

but since Q4 2012 the market seems to have discounted them as growth recovers

We believe the market is underestimating the risks in China and that growth will slow in H2 2013

We elaborate our concerns, highlight where the risks lie and discuss how they might play out

Fig. 2: China GDP growth forecast: Nomura vs Consensus


% y-o-y

Consensus forecast
Nomura forecast Actual

8.5

65 8.0 60

7.5

55

50 Mar-12

Jun-12

Sep-12

Dec-12

Mar-13

7.0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

Source: Bloomberg and Nomura Global Economics.

Source: Consensus Economics and Nomura Global Economics.

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15 March 2013

Symptoms of financial risks


1. Rapid build-up of leverage
Empirically, the build-up of leverage has been identified as a simple but tried and tested leading indicator for financial crises in academic research. There is a long list of academic literature on this, growing quickly due to the higher frequency of crises in recent years that drives a need for useful early warning indicators (see Zhang, 2001, for research on the Asian financial crisis; Frankel and Saravelos, 2011, for an extensive reference list on the global financial crisis). Intuitively, it makes sense why leverage works as a leading indicator of financial crises. Through history, bubbles have often been preceded by grand economic miracles, real or illusionary. The 1840s saw the birth of British railway mania after the worlds first inter-city railway, connecting Liverpool and Manchester, opened in 1830 and proved highly successful. A hundred and fifty years later, Japans bubble was preceded by 30 years of rapid economic growth. The dotcom bubble in the late 1990s claimed the backing of technological revolution; while before the global crisis of 2008, the US housing bubble was described as the great moderation due to central bankers who had won the battle against inflation and put an end to business cycles. In such cases investors and firms leveraged up to maximise returns, assuming past performance would continue in the future. Leverage in Chinas economy, as measured by the domestic credit-to-GDP ratio (DCG hereafter), has reached its highest level since data was made available in 1978. Domestic credit is defined as claims by deposit taking institutions, mostly loans and government and corporate bonds held by banks and credit unions. The DCG ratio was 120.8% before the global financial crisis but has risen sharply since as the government implemented proactive fiscal and monetary policies to support growth and relied on bank loans to finance the fiscal expansion (Figure 3). Some analysts and government officials believe that China's leverage is unalarming compared to other economies, arguing that the average level of DCG in OECD economies was 211% in 2011, higher than the current level in China (Figure 4). Moreover, of the large economies that have experienced major financial crises, they experienced much higher levels of leverage than China today Japans DCG ratio was 237% in 1989; it was 224% in 2008 in the US; and it was 158% in Europe in 2009. If we take Japan's DCG in 1989 as a benchmark of sorts, then China still has a very long way to leverage up before reaching the "crisis zone".
Fig. 3: Chinas domestic credit-to-GDP ratio
% of GDP 155

Academic research shows high leverage causes financial crises

A rise in leverage has preceded many major financial crises in the past

Leverage of Chinas economy has reached an historical high

Some argue leverage is not as high as in developed countries such as Japan, so there is no need to worry

Fig. 4: Domestic credit-to-GDP comparison


% of GDP 250

200

135

150

100

115
50

95
1997 2000 2003 2006 2009 2012

China Thailand OECD (2012) (1997) (2011)

Spain (2011)

Japan (1989)

US (2007)

Source: IMF, CEIC and Nomura Global Economics.

Source: IMF, World Bank and Nomura Global Economics. We believe comparing the level of leverage across countries is misleading

However, we believe it is misleading to compare the level of leverage in China to that of developed economies. First of all, the average DCG ratio for OECD countries should not be taken as a healthy benchmark as many developed economies are in debt crises it makes little sense to argue that a person standing close to a cliffs edge is safe because hes standing so much higher than those who have already fallen off it. Neither does it make sense to compare

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the level of leverage in China today with that in Japan 25 years ago as it fails to take into account the country-specific conditions of the different eras, such as, for example, the development of financial markets and the level of financial assets in the economy. A better approach to compare different countries' experience is to assess not only the level of leverage, but also the change in leverage. A high but stable level of leverage does not necessarily suggest high risks, but a rapid build-up of leverage (i.e., where credit growth outpaces GDP growth) should make both investors and regulators vigilant. In that sense we need to worry about China. Its leverage, measured by the DCG ratio, rose quickly from 121% of GDP in 2008 to 155% in 2012 (Figure 5). Looking at China's history over the last 30 years, there was a similar build-up of leverage in the 1990s which made the whole banking sector insolvent. After Deng Xiaopings famous Southern tour in 1992, China began an investment boom which ultimately led to economic overheating and high inflation. Leverage rose quickly, as the DCG ratio climbed 24 percentage points (pp) from 1994 to 1998. Policy had to tighten to contain inflation, and then the Asian financial crisis amplified the cycle as the government pushed expansionary policies to offset a decline in exports. Consequently, China went through a long and painful deleveraging process from 1998 to 2004. According to the World Bank, the non-performing loan (NPL) ratio in China's banking sector rose to a high of 29.8% in 2001 and the government had to restructure the major banks by injecting public funds and removing bad loans to asset management companies.
The change of leverage is a leading indicator for crises

Chinas leverage rose by 34% of GDP in five years a worrying sign given its history

The 5-30 rule


International comparison also suggests the build-up of leverage since 2008 is dangerous. We notice an interesting common phenomenon which we call the "5-30 rule" where financial crises in large economies are usually preceded by the leverage ratio rising sharply by 30% of GDP in the five years before the crisis is triggered (Figure 6). In Japan, the DCG ratio rose from 205.9% in 1985 to 237.4% in 1989. The stock market peaked in December 1989 and the economy entered its lost decade the average GDP growth rate fell to 2.0% from 1989 to 1998 from 4.4% from 1979 to 1988 (Figure 7). In the US, the 5-30 rule can be applied to two crises in the past 15 years (Figure 8). During the tech bubble, the DCG ratio rose by 36% of GDP, from 173% in 1995 to 209% in 1999. The bubble burst in 2001, dragging GDP growth down by 3pp from 2000 to 2001. The Federal Reserve lowered interest rates, which saw the formation of the housing bubble that burst in 2008. The DCG ratio rose by 30% of GDP to 244% in 2007 from 214% in 2003.
Fig. 6: Change in domestic credit to GDP, five-year rolling window
Changes (pp) 45

Leverage in Japan, the EU and the US rose by around 30% of GDP in the five years before entering a crisis

Fig. 5: Chinas domestic credit to GDP ratio and its change based on a five-year rolling window
% of GDP 160 Domestic credit/GDP Changes (pp), rhs pp 40 30 140 20 10 120 0

Japan (1985-89)
China (2008-12)

US (2003-07)
US (1995-99)

30

15

100

-10 -20
-15

80 1991 1994 1997 2000 2003 2006 2009 2012

-30

-30 t-4 t-3 t-2 t-1 t

Note: The gray line shows the change in the DCG ratio in a given year from five years earlier e.g., the reading in 2012 is 34pp because the leverage ratio rose to 155% of GDP in 2012 from 121% of GDP in 2008. Source: IMF, CEIC and Nomura Global Economics.

Note: Year t refers to 1989 in Japan, 1999 and 2007 in the US and 2012 in China. The lines show how fast leverage built up e.g., the line for China shows its DCG level declined by 20pp from 2004 to 2008, then increased by 34pp from 2008 to 2012. Source: IMF, CEIC and Nomura Global Economics.

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15 March 2013

In the European Union, the DCG ratio rose by 26% of GDP over the period 2006-10, from 134% to 160% (Figure 9).

While the 5-30 rule may provide a useful handle as a financial crisis indicator, of course there is room for the DCG ratio to grow by more than 30% of GDP over the timeframe in Thailand, for example, the DCG ratio rose 46% of GDP from 131% in 1994 to 177% in 1998 (Figure 9). Still, given the size of the economy, we believe it more appropriate to compare China to Europe, Japan and the US. Moreover, China's own experience in the 1990s suggests that the DCG rising by 34% of GDP in five years is a dangerous extension of credit the infamous GITIC (Guangdong International Trust and Investment Corporation) default happened in 1998, when the DCG ratio rose to 110% from 86% in 1994.
Fig. 7: Domestic credit-to-GDP and its change, five-year rolling window Japan
% of GDP 250 Domestic credit/GDP Changes (pp), rhs pp 35

Fig. 8: Domestic credit-to-GDP and its change, five-year rolling window US


% of GDP 250 Domestic credit/GDP Changes (pp), rhs pp 40

230
210

30
25

30 220 20

190
170

20
10

15

190

150
130 1974 1978 1982 1986 1990 1994

10
5

160 1993 1996 1999 2002 2005 2008 2011

-10

Note: Nikkei 225 stock index peaked in 1989 when the asset bubble burst. Source: IMF, CEIC and Nomura Global Economics. Fig. 9: Domestic credit to GDP and its change, five-year rolling window EU
% of GDP 160
Domestic credit/GDP Changes (pp), rhs 140 20 pp 30

Note: NYSE composite index peaked in 2000 and 2007 respectively when the IT bubble and financial crisis broke out. Source: IMF, CEIC and Nomura Global Economics. Fig. 10: Domestic credit to GDP and its change, five-year rolling window Thailand
% of GDP 200 Domestic credit/GDP Changes (pp), rhs pp 70

170

40

140 120 10 110

10

-20

100 1993 1996 1999 2002 2005 2008 2011

80 1990 1993 1996 1999 2002 2005 2008

-50

Note: The European debt crisis broke out in 2009. Source: IMF, CEIC and Nomura Global Economics.

Note: Asia crisis broke out in 1997. Source: IMF, CEIC and Nomura Global Economics. Actual build-up of credit may be higher than official data suggest

The rise of leverage in China is clearly troublesome, but the problem actually extends beyond that implied by the DCG ratio. The DCG ratio only captures credit provided by the official banking system and does not include credit supplied through the bond and equity markets, or the shadow banking system (i.e., lending activity that does not show up on bank balance sheets is less transparent and less subject to supervision, regulation and capital requirements). Credit extension outside the banking system has become increasingly important since 2008 as the

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15 March 2013

government tightened regulations on bank lending. The 20% reserve ratio requirement on bank deposits, earning a very low rate of interest, smacks of financial repression and has most likely encouraged the disintermediation.

Total social financing data offers a more comprehensive picture


In April 2011, the PBoC began to publish a total social financing (TSF) statistic which attempts to measure overall credit supply to the economy, encompassing not only bank loans but other credit channels as well. It measures the net flow of credit (i.e., new issuance minus expiring credit). Figure 11 shows a breakdown of TSF. The main components are: Bank loans. Standard loans made by banks, which fall into the loan quota set by regulators. This has been the most dominant force in credit supply, but its share in TSF has tumbled from 95.5% in 2002 to 57.9% in 2012. The sharp rise of bank loans since 2008 has been largely driven by lending to local government financing vehicles (LGFVs). According to official news agency Xinhua, Mr. Shang Fulin, the head of the CBRC, said last November that the amount of total outstanding bank loans to LGFVs was around RMB9.25trn at September 2012, or 14.1% of total bank loans. Trust loans. This refers to loans arranged by trust companies, which are non-bank financial institutions. They raise funds from retail and institutional investors before channeling them into specific projects. They are not constrained by bank loan quotas set by the regulators. The amount of new trust loans soared to RMB1.289trn in 2012 from just RMB203bn in 2011 as regulators tightened controls on bank loans to property developers and LGFVs, but left the trust loan channel open for these borrowers hence a 534.3% rise of new trust loans issued in 2012. Entrusted loans. These refer to lending from one company to another through the banks. Direct lending from one corporate to another is illegal in China, so cross-firm lending goes through the banking system. Corporate bonds. The amount of issuance has risen sharply in recent years to RMB2.25trn in 2012 from just RMB552bn in 2008. This is partly driven by deregulation of the bond market as regulators intentionally loosened control to foster the markets development to diversify risks from the banking sector, and partly due to the same reason trust loans soared tight control on bank lending squeezed demand from LGFVs into the bond market.
Total social financing statistics capture some shadow-banking activities and give a better picture of credit supply

Fig. 11: Total social financing and its main components (flow)
(RMB bn) TSF estimated by Nomura Government bonds Underground lending TSF released by the PBC New loans Trust loans Corporate bonds Short-term bill NF equity financing & entrusted loans Others 2004 3328 326 140 2863 2406 0 47 -29 379 61 2005 3438 292 145 3001 2496 0 201 2 230 71 2006 4701 240 191 4270 3298 83 231 150 423 85 2007 7993 1793 233 5966 4019 170 229 670 770 108 2008 7510 234 296 6980 5099 315 552 107 759 150 2009 15388 867 610 13911 10521 436 1237 461 1013 243 2010 15494 986 489 14019 8430 386 1106 2335 1454 308 2011 14050 755 466 12829 8043 203 1366 1027 1734 455 2012 17068 778 529 15761 9120 1289 2250 1050 1535 518

Source: CEIC and Nomura Global Economics estimates.

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15 March 2013

Banker acceptance bills. These are a promised future payment issued by firms that are accepted and guaranteed by commercial banks. After acceptance, the bill becomes an unconditional liability of the bank, but the holder can sell (exchange) it for cash at a discount to a buyer who is willing to wait until the maturity date. Banker acceptances are frequently used in money market funds. Equity financing. Equity market IPOs have slowed in recent years due to bearish market conditions.

but still has its limitations


While providing a better picture than the domestic credit-to-GDP ratio, TSF data still fails to account for two other credit channels. One is public financing, which includes bond issuance from both the central and local governments. In 2012, central government bond issuance was RMB1.356trn, while local government bond issuance was RMB250bn. The two combined suggest public bond issuance rose by 0.4% in 2012 from 2011. Note that this is a rather narrow definition of public financing bond and trust issuance and bank lending by LGFVs are also liabilities on the governments balance sheet. We discuss the public versus private composition of outstanding credit later. The other channel is underground lending, which is reportedly active in some regions such as Wenzhou and Erdos. There is little reliable data on the aggregate size of underground lending, but the 21 Century Business Herald reports that the PBoC conducted a survey in mid-2011 and concluded that the stock was RMB3.38trn, equivalent to 5.8% of total bank loans in 2011. We can add these channels to the TSF number, using official data for public bond issuance and FDI, while for underground lending we estimate the full time series by assuming a constant share (i.e., 5.8%) of total outstanding bank loans. Figure 11 tabulates our estimate of its flow. Our estimate shows the stock of total TSF has risen by 62% of GDP to 207% in 2012 from 145% in 2008. The build-up of leverage is faster than that suggested by the official TSF-toGDP ratio which shows a 58%-of-GDP increase from 129% to 187%, much faster than the domestic credit-to-GDP ratio, which rose 32% of GDP to 153% from 121% over the same period (Figure 12). We believe that total TSF is the best leading indicator of government policy in China. In recent years, the growth rate of TSF has a better lead-lag relationship with GDP growth than the growth of bank loans (Figure 13), largely because the government no longer relies on bank loans as the primary source for policy guidance as it recognises that many banks are already in difficult positions. After the global financial crisis hit Chinese exporters in 2008, the government introduced its RMB4trn fiscal stimulus and banks were ordered to lend to LGFVs. Total bank loans to LGFVs stood at RMB9.25trn in September 2012, which accounted for 14.1% of total bank loans. The government decided to allow the bond market and trust loans to take the bulk of policy easing in 2012; indeed, bank loan growth grew only 12% y-o-y in H2 2012, while nonbank credit growth soared by 164% y-o-y.
Fig. 12: TSF (total stock) to GDP ratio
% of GDP 220 Total social financing (by the PBoC) Total social financing (by Nomura) Domestic credit

But TSF does not include government debt

or underground financing

Adding these, the TSF-to-GDP ratio rose sharply to 207% in 2012

TSF measures credit growth better as most has taken place outside the banking system in recent years

Fig. 13: Growth of TSF and GDP


% y-o-y 35

Total social financing (stock) GDP, rhs

% y-o-y 15

190

30

13

25

11

160
20
130

15

100
2004 2006 2008 2010 2012

10 Dec-04

Dec-06

Dec-08

Dec-10

5 Dec-12

Source: IMF, CEIC and Nomura Global Economics.

Source: CEIC and Nomura Global Economics.

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15 March 2013

2. Rapid asset price inflation


A BIS report in 2009 (Boris and Drehmann) identified that unusually strong increases in credit and asset prices have tended to precede banking crises, and found them successful in providing a signal for several banking systems currently in distress, including that of the United States. In our view, China faces a much higher risk of a property price bubble bursting than an equity price bubble. Indeed, it is arguable that an equity price bubble has already been experienced the Shanghai Stock Composite Index rose 461% between May 2005 and October 2007 from 1,060 to 5,954 before collapsing in October 2008 to 1729 and is now around the 2,300 level. The collapse of the stock market did not have much of a damaging effect on the economy as the market was dominated by retail investors who were not heavily leveraged, therefore the negative price effect did not spillover into the banking sector. If we look at the official housing price data, then property sector conditions seem rather benign, with prices rising by only a very moderate, cumulative 113% over the period 2004 to 2012 in major Chinese cities (Figure 14). However, the quality of the official housing price index is highly questionable and it contradicts our observations on the ground and recent academic research on the topic. The problem may be due to the fact that Chinas property market went through a rapid phase of development since 2004 and the quality of new properties is very different from the old ones. An accurate property price index needs to control for changes in quality to provide a fair like-for-like comparison over time what in technical terms is called an hedonic price index. A recent academic paper provided a hedonic index for 25 major cities. According to three professors in Tsinghua University and National University of Singapore (Wu, Deng and Liu, 2013), property prices rose by 250% from 2004 to 2009, far outstripping the level of growth in the official index. By comparison, it also rose faster than the Case-Shiller US housing price index, which climbed by 84% from 2001 to its peak in 2006. Furthermore, land prices rose even more sharply than property prices (Figure 15). According to official statistics, the average price per square metre of land at sale was just RMB573 in 2003 (USD69.2 on the 2003 exchange rate), rising to RMB3,393 in 2012 (USD537) a 492% rise over 10 years. Another academic paper (Wu, Gyourko and Deng, 2012) found land prices in Beijing rose 800% from Q1 2003 to Q1 2010 after adjusting for quality difference. The average sale price for properties per square metre rose from RMB2,378 in 2003 to RMB5,791 in 2012, a 143% appreciation over 10 years. It is not surprising that many state-owned companies made aggressive moves in the land auctions and that hoarding of land is a common problem as of 2012 there was 402mn square meters of land already purchased by developers but not yet developed, equivalent to 10.3% of total land sales in the past 10 years.
Rapid asset price inflation usually precedes banking crises

The equity market does not pose a threat in China at this stage, in our view

Official property price data seriously understate risks in this sector

An appropriate price index shows Chinas property prices rose more than those in the US housing bubble

Fig. 14: Housing price indexes China and US


Jan 2000=100 300 275

Fig. 15: Average land sale price and property sale price
2003=100 600

China
US: CS housing index
Land price 500 Property price

250
400

225 200 175 150 125


100 300

200

100 Dec-00

Dec-03

Dec-06

Dec-09

Dec-12

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: CEIC, WIND and Nomura Global Economics.

Source: CEIC and Nomura Global Economics.

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15 March 2013

The government obviously recognises the risks in the property sector. It has introduced a series of progressively tighter policies to contain property prices over the past several years, including raising the down-payment ratio for second-home purchases, limiting home purchases by nonlocal families, applying stricter criteria when levying land value-added tax from real-estate developers, prohibiting mortgages for a third home (or higher) purchases, and limiting bank lending to real estate developers. The pattern has been for house prices to initially dip after tightening policies are introduced, then to rebound, which suggests that the risks have not been mitigated. In early September 2012, land auctions suddenly turned hot again as large developers many of them state-owned enterprises pushed up bidding. The Shanghai Stock Exchange Property Index rebounded sharply by 29% from August 2012 to January 2013. Fixed asset investment growth in the housing sector also picked up. The recovery in the housing market is not, in our view, a reflection of improved underlying fundamentals, as inventory on a national level remains high (Figure 16). Another round of measures, including the 20% capital gains tax, was implemented on 1 March and M2 growth will likely fall from 15.2% in February as the government has set its target at 13% for 2013, which should pose downside risks to both property prices and investment (Figure 17).
Fig. 16: Floor space started and sold
Square meter mn (12 month rolling sum basis) 2,000

The government has been trying to contain a property bubble

Property prices and investments were weak, but have picked up again recently

leading to another round of tightening and downside risks to the property sector

Fig. 17: Property price growth and M2 growth sold


% y-o-y 18 15 12 9 6 3 % y-o-y 70 city property price, lhs 31 28 25 22 19 16 13 10 Feb-13

M2 growth, rhs
1,600 Floor space started Floor space sold 1,200

800

400

0
0 Feb-01

Feb-04

Feb-07

Feb-10

Feb-13

-3 Feb-05

Feb-07

Feb-09

Feb-11

Source: CEIC and Nomura Global Economics.

Source: CEIC and Nomura Global Economics.

10

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3. Decline of potential growth


Financial crises often follow technology revolutions and/or so-called economic miracles, because investors and policymakers start to overestimate the potential growth of the economy. Policymakers may misinterpret a structural slowdown in potential growth as cyclical and utilise expansionary policies to boost growth, which leads to a further deviation of actual GDP growth from its potential level, planting the seeds for overheating and an eventual painful correction. The decline of potential growth is a useful leading indicator of financial crises. Classic economic theory says that potential growth is driven by the growth of three factors: labour, capital and total factor productivity. In many cases, the slowdown in potential growth is mainly a result of weaker productivity growth. In the US, academic research shows potential growth dropped to 2.0% for the period of Q2 2007 to Q2 2008 from the 10-year average of 2.8% (Robert Gordon, 2008), while an OECD study shows labour productivity declined significantly prior to the crisis, particularly in the construction sector (Brackfield and Martins, 2009). A report from Banco de Espana shows Spains potential growth fell to 2.6% in 2006 and 2.2% in 2007 from an average of 3.2% over 2000-05 (Hernndez de Cos, Izquierdo and Urtasun, 2011). Another study, this from the Brookings Institute, shows that Spains productivity growth had been on a slide since 1995 but the pace of decline picked up after 2004, according to data from European Central Bank (Baily, 2008). In Japan, productivity growth slowed in 1980 compared to the 1970s, according to data from the Research Institute of Economy, Trade and Industry. In China, there are also signs of a slowdown in potential growth, driven by a decline of both the labour force and productivity growth. We discuss the productivity issue first. Unfortunately there are no up-to-date and reliable productivity data available in China. In an effort to find an alternative way to evaluate countries' productivity, we examine global export market shares, which we prefer over export growth as it provides a reflection of exporters competitiveness and is not influenced by changing global demand conditions. Global export market share works well as a leading indicator of financial crises in Japan (1989), the US (2008), Europe (2009) and Thailand (1997). Japanese exporters share of global exports peaked in 1986 after the Plaza Accord as they gradually lost market share to low-cost competitors such as South Korea (Figure 18). US exporters share of global exports was around 12% in the 1990s, but declined steadily to 8.1% in 2008 (Figure 19). Spanish exporters share of global exports dropped to 1.6% in 2010 from 2.1% in 2003 (Figure 20). Thailands market share was on an uptrend throughout the 1980s but peaked in 1995 (Figure 21), partly because Chinas export competitiveness picked up and crowded out some Thai exporters (Federal Reserve Bank of Atlanta, 1999).
Decline of potential growth often precedes financial crises

driven partly by a productivity slowdown, as seen in Japan, Europe and the US before they entered crises

We use export market share as a measure of productivity

which fell before crises in Japan, the US, Europe and Thailand

Some may wonder why global export market share worked well in predicting financial crises given the fact that not all of the above economies are export-dependent; the US, for example, is much more driven by domestic than external demand. We believe the reason is because changes in export market share are a good indicator for changes in competitiveness and productivity of the overall manufacturing industry. The latest economic research in academia shows that, in a given economy, more productive firms move across borders to compete in global markets (Melitz and Redding, 2012; Manova and Zhang, 2012). Therefore, if there is a broad-based productivity slowdown, exporters' market share in the global market would shrink even if exports are not a pillar of growth in that economy. The market-share analysis shows that China gained competitiveness rapidly before 2010, but progress has since come to a halt. We do not have the global trade data for full-year 2012 yet, but taking Chinas market share in the US as a proxy it appears to have peaked in 2010 (Figure 22). This suggests that the rapid productivity growth after WTO accession has likely ended. For labour intensive industries such as footwear and apparel, Chinese exporters market share has fallen (Figure 23), which has offset the rising share of capital intensive goods.
Market share of Chinese exporters rose sharply before 2010, but has since stalled

11

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Fig. 18: Japans market share in global export market


% of total
12

Fig. 19: US market share in global export market


% of total 13

12
10

11

10

9
6

8
4 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011

7 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Note: Nikkei 225 stock index peaked in 1989 when the asset bubble burst. Source: IMF, CEIC and Nomura Global Economics. Fig. 20: Spains market share in global export market
% of total 2.2

Note: NYSE composite index peaked in 2007 ahead of the global financial crisis. Source: IMF, CEIC and Nomura Global Economics. Fig. 21: Thailands market share in global export market
% of total
1.4

2.1

1.2

2.0

1.0

1.9

0.8

1.8

0.6

1.7

0.4

1.6 1996 1999 2002 2005 2008 2011

0.2
1983 1987 1991 1995 1999 2003 2007 2011

Note: The European debt crisis broke out in 2009. Source: IMF, CEIC and Nomura Global Economics. Fig. 22: Chinas market share in US market

Note: Asia crisis broke out in 1997. Source: IMF, CEIC and Nomura Global Economics. Fig. 23: Chinas market share in US: labour intensive vs capital intensive goods
% 80 Labour intensive products, lhs % 55

% of total 25

Capital-intensive products, rhs 72 46

20
64 37

15
56 28

10

48

19

5 1994 1997 2000 2003 2006 2009 2012

40 Nov-00

Nov-03

Nov-06

Nov-09

10 Nov-12

Source: CEIC and Nomura Global Economics. Note: total US imports excluded oil imports.

Note: 12m moving average; for labour-intensive goods we cite footwear; while for capital-intensive goods we cite telecom and sound equipment. Source: CEIC and Nomura Global Economics.

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We believe China's global export market share likely peaked in 2012. The three main sources of China's competitiveness demographics, an undervalued currency and reform dividends have all weakened since 2008. On the demographics side, trends that were working in Chinas favour before 2008 have now turned against it. The demand supply ratio in the urban labour market is arguably the best indicator of wider labour market conditions in China. The ratio was persistently below 1 before 2009, suggesting the labour market was over-supplied, mostly due to the large influx of migrant workers from inland rural areas. But in 2009 the trend reversed. The ratio climbed above 1 in Q4 2009 and remained there for 12 consecutive quarters. Even when GDP growth slowed to 7.4% in Q3 2012, the ratio remained above 1 (Figure 24), which suggests to us that the potential growth rate has likely slowed to 7.0-7.5%. Working-age population. The United Nations projected that Chinas working-age population would peak in 2015. This projection has been widely cited in China and taken as a working assumption for many policymakers and researchers, but the data show that Chinas working-age population began to decline in 2012 (Figure 25), having grown for at least the past 20 years.

We believe Chinas market share will fall as the labour force starts to contract

On the currency side, RMB has appreciated by 22.9% against the US dollar and 25.7% in relative effective exchange rate (REER) terms between 2005 and 2012. Its appreciation against some emerging market currencies has been particularly significant for example, one RMB could be exchanged for IDR1,191 in 2005, but had strengthened 25.4% to IDR1493 in 2012 (Figure 26). During the same period, RMB appreciated by 57.4% and 56.8%, respectively, against the Indian rupee and the Mexican peso. The real economic effects of the labour market tightening and currency strength caused the wage differential between Chinese workers and Indonesian workers to widen significantly over the same period. The average wage in China was about twice that in Indonesia in 2000, but by 2011 this had risen to 3.5 times (Figure 27). Over the period of 2000 and 2011, cumulative wage growth in China was 473.7%, much higher than 238.6% in Indonesia, 137.2% in India and 46.3% in Mexico. Can productivity growth in China offset the rising wage differential between China and emerging markets such as Indonesia? We believe it is unlikely. The slowdown in reform momentum since WTO accession in 2001 is hurting China's productivity growth today. There is widespread complaint in China's policy circles and the media over the slow progress of major reforms. The government has relied heavily on Keynesian-style infrastructure investments to boost growth and avoided difficult structural reforms such as moving to a fully market-based monetary policy framework and opening up the service sector that is monopolised by the SOEs. As the three main sources of Chinas competitiveness run out of steam, China is no longer as attractive to foreign investors. Indeed, FDI into China used to grow faster than FDI to other developing countries, but this trend is changing (Figure 28). A recent survey by Japan Bank for International Cooperation shows China's popularity among Japanese companies declined sharply in 2012 while Indonesia's popularity rose (Figure 29). This suggests FDI growth in China may face downward pressure in the years ahead as well. FDI is also a leading indicator for exports; as China increasingly relies on public investment over private and foreign investment, its productivity faces downside risks.

RMB has appreciated significantly against other currencies

and structural reforms have slowed in recent years

China becomes less attractive for FDI as its competitiveness fades

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Fig. 24: China labour demand supply ratio and GDP growth
Ratio 1.2 Labour demand/supply ratio % y-o-y 16

Fig. 25: Chinas working-age population


% y-o-y
5 Working-age population growth GDP growth, rhs

% y-o-y
15 14 13

GDP growth, rhs


1.1 14

3
1.0 12

12 11

2
0.9 10

1
0.8 8

10
9

8 7 1992 1996 2000 2004 2008 2012

0.7 Dec-03

Dec-06

Dec-09

6 Dec-12

-1

Source: CEIC and Nomura Global Economics.

Source: CEIC and Nomura Global Economics.

Fig. 26: Exchange rate comparison


July 2005=100 180 170 160 150 140 IDR/RMB INR/RMB MXN/RMB RMB appreciation versus other currencies

Fig. 27: Wage level comparison


USD 8,000 7,000

India
China

Indonesia
Mexico

6,000
5,000 4,000

130

3,000
120 110
100 90 Dec-06

2,000 1,000 0
Dec-08 Dec-10 Dec-12

2000

2011

Source: CEIC and Nomura Global Economics.

Note: For India, the wage is rural wage level. Source: CEIC and Nomura Global Economics.

Fig. 28: FDI growth China vs developing economies


% y-o-y 30 25 20 15 10 5 0 China Developing economies excluding China

Fig. 29: Japan FDI survey


% share 100 90 80 70 60 50 China Thailand Indonesia India Vietnam Brazil

40
30 20 10 0

-5
-10 -15 -20 -25 2008 2009 2010 2011 2012

(FY)

Source: CEIC and Nomura Global Economics.

Source: Japan Bank for International Cooperation and Nomura Global Economics.

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Identifying the risks


In this section we delve deeper to evaluate the vulnerability of major economic sectors. The ideal approach is to get a solid estimate of the balance sheets of the major sectors the government, banks/financial institutions, households and corporates. This "balance sheet approach" has proved useful in analysing past financial crises (Koo, 2012). For instance, the financial condition of the government sector remains a key driving factor in the European crisis, while the deterioration of bank balance sheets was a major reason behind the Japanese financial crisis. That said, we cannot fully follow the balance sheet approach in China due to data constraints. Consolidated balance sheets are not available for the household or corporate sector. For the financial sector, we have information on listed banks which constitute most of the banking sector, but as we discuss later, the more serious risks are more heavily skewed towards the non-bank financial institutions such as trust and guarantee companies. On the government sector there are some estimates from think-tanks, but these are largely outdated. Nonetheless, it turns out that with the available information we can conclude that the main risks lie mostly in three areas: local governments, property developers and non-bank financial institutions.
We identify and evaluate the risks in the major sectors of the economy

Government finances
The central government is clearly in good financial condition. The public debt-to-GDP ratio was only 15.2% in 2011, while foreign currency-denominated debt only accounted for 0.9% of total central government debt. The fiscal balance has registered a deficit in recent years, but the deficit has been limited to below 3% of GDP. Moreover, on the asset side, the government holds USD3.3trn of FX reserves, while the value of SOE assets reached RMB85.37trn in December 2011. Financial conditions in the general public sector are not nearly as favourable. There is no official consolidated balance sheet for the central and local government. The Chinese Academy of Social Science (CASS), an official government think-tank, published its estimate of China's consolidated public balance sheet for 2010, including the central and local governments, as well as the SOEs (Li and Zhang, 2012). The CASS study claims that the public sector in China should be considered solvent because of potential revenue from selling natural resources such as land, and privatisation of SOEs (Figure 30). CASS estimates total public sector assets of RMB142.3trn in 2010 against total liabilities of just RMB72.7trn. On the asset side, however, the two major items that could be sold to pay down debt are natural resources (RMB44.3trn) and SOEs (financial and non-financial, combined, at RMB67.3trn). Local governments have relied heavily on land sales as a major source of debt financing in recent years. Privatisation of the SOEs has not yet been utilised as a major source of funds, but we expect it will likely take the spotlight in coming years.
Fig. 30: Chinas public sector balance sheet, 2010
Total Assets Government deposit in the PBoC Reserve asset Natual resources including land SOA in administrative public entities SOA in non-financial enterprises SOA in financial institutions SOA in national social security fund RMB trn 2.4 19.7 44.3 7.8 59.1 8.2 0.8 Total Liabilities Central government's domestic debt Sovereign debt Local government debt (excluding LGFV) Debt of LGFV Debt of non-financial SOEs (excluding LGFV) Debt of policy banks NPL of banks Potential debt from solving NPL Implicit debt from pension fund Total assets 142.3 Total liabilities Public sector net assets RMB trn 6.7 2.3 5.8 9.0 35.6 5.2 0.4 4.2 3.5 72.7 69.6

The central government is in good financial condition

but local governments face tough challenges

Source: CASS.

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Local governments have ramped up their debt


While the overall public sector does not have a solvency problem, local governments are facing tough challenges, at least from a liquidity perspective. The CASS study shows local government debt amounting to RMB14.8trn by 2010, which includes RMB5.8trn of explicit government debt and RMB9trn on LGFV balance sheets. Furthermore, we believe the situation since has only worsened for local governments. While we do not have detailed information to update the full set of government balance sheets for 2012, we can offer an update on central and local government debt levels, which we estimate at a combined RMB24.9trn, or 47.7% of GDP in 2012. This was mostly due to a further increase of local government liabilities through trust loans of RMB154bn and bonds of RMB2.1trn (urban construction bonds and local government bonds). Most local government investment is not yet profitable, because of the large share that has gone into infrastructure projects, such as the building of subways and highways, which require substantial investment upfront but take many years to break even. Indeed, financial statements disclosed by most LGFVs who sought capital from the bond market show negative cash flows. Tianjing Urban Construction Company, the largest LGFV in the country, reported that its cash flow in 2011 fell to -RMB31bn from -RMB7bn in 2010. It has not yet released its 2012 financial statements. Many LGFVs have managed to stay solvent because local governments provided new capital, subsidies and guarantees to allow them to issue new debt. New capital is often in the form of land, the value of which is subject to substantial market risks. The guarantees by local governments are critical to LGFVs if they are going to continue to tap the bond market. However, we believe local government support of their LGFVs will come under increasing pressure. Local governments have relied heavily on land sales in the past to generate revenue (Figure 31), but land-sale revenues were broadly flat in 2011 and 2012 due to policy tightening. Land sales in January/February (combined) were down 12% y-o-y and we believe the round of policy tightening announced on 1 March makes it unlikely that they will experience rapid growth in 2013. When land sales failed to provide the required incremental growth in funding for LGFVs in 2012, they turned to urban construction bonds and infrastructure trust products. Urban construction bonds are issued by the LGFVs themselves and new issuance soared to RMB1.2trn in 2012 from barely RMB29.4bn in 2006 (Figure 31). Infrastructure trust products are essentially private placements of loans arranged by trust companies, that channel funding from retail, corporate and institutional investors to the LGFVs. Issuance of infrastructure trust products rose to RMB112bn in 2012 from RMB39.3bn in 2011 (Figure 32).
We estimate government debt to be RMB24.9trn, or 48% of GDP in 2012

Most LGFV investments will incur at least short-term losses

LGFVs are solvent because of local government support

But local government land-sale revenues face downside pressure

LGFVs relied on bond issuance in 2012 to raise funds

Fig. 31: Land sales revenue and urban construction bond issuance
RMB bn 3500 RMB bn

Fig. 32: Issuance of trust products for infrastructure investment


RMB bn 120

Land sales revenue, lhs


Urban construction bond, rhs

1400

3000
2500 2000 1500 1000 500

1200
1000

100
80

800 60 600 40 400 200 20

0
2006 2007 2008 2009 2010 2011 2012

0
2004 2006 2008 2010 2012

Source: WIND, CEIC and Nomura Global Economics.

Source: WIND and Nomura Global Economics.

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but future funding will be harder to come by


It is not clear to us how the LGFVs will be able to finance their growing investments in 2013 and beyond. We estimate the current outstanding debt of LGFVs at around RMB11trn. Assuming 10% of the principle becomes due in 2012 and an interest rate of 6%, the LGFVs would need RMB1.76trn just to repay existing debt more than the total amount of urban construction bonds issued in 2012. Moreover, the central governments plan to cut M2 growth to 13% in 2013 from 14% in 2012 means overall credit supply will be tightened in 2013. It will be difficult for LGFVs to continue their investment spree as they run out of new funding sources. This mounting pressure has already pushed some local governments to take unconventional measures to finance their investments. A typical example is the so-called BT (build-transfer) model, whereby the local government asks a private company or a state-owned enterprise to handle an investment project and agrees to buy it at a set price when it is completed. One example is Lanzhou city, where the government despite total revenues of only RMB8.6bn in 2011 promised to pay the Pacific Group RMB80bn for the construction of a new city next to the existing urban area. In terms of accounting or judging balance-sheet strength, the BT model leads to liabilities in the future, but does not show up in official government debt statistics. Perhaps rather unsurprisingly, it is not known exactly how much of this sort of debt is outstanding, although it is generally understood that the practice is pervasive among local governments. Of course, it is no secret that the central government is concerned about the state of local government finances. On 31 December, 2012, the Ministry of Finance, the PBoC, the National Development and Reform Commission and the CBRC issued a joint statement banning the BT financing model alongside other innovations at the local government level, to avoid a rise in contingent liabilities. There is a long list of what local governments cannot do, but there is no clear solution as to what they can do to meet their spending obligations.
but it is getting harder to finance a growing appetite for funds and to repay debt

Local governments have resorted to unconventional measures to raise funds

which the central government is trying to ban

Financial sector conditions


Banks
We believe the banks are also worse off now than in 2008. Bank weakness comes from three main sources. The first is loan exposure to LGFVs, which reached RMB9.25trn as of September 2012, which accounted for 14.1% of total outstanding bank loans (Figure 33). The CBRC has put tight controls on the banks to not extend new credit to LGFVs, but the outstanding amount has not fallen in recent years despite the short maturity of these loans, which suggests expired loans have been rolled over. The second source is exposure to property developers. The size of loans made to property developers has been constrained by regulators, but at end-2012 stood at RMB3.9trn, or 6.2% of total loans outstanding. The risks from exposure to LGFVs and the property sector are relatively more transparent as these loans sit on banks balance sheets and their NPLs are provided in quarterly reports. At the moment, the NPL ratio for the five major banks is only 1.2% (Figure 34), and with huge net profits of RMB1.24trn in 2012, there is a buffer through which they can absorb losses even if the NPL ratio was to rise to 1.8%. Tight regulations on bank new loans to LGFVs and property developers should help mitigate these risks. A far more problematic and less transparent risk stems from so-called wealth-management products (WMPs) that banks sell to retail investors. According to the CBRC, the amount of WMPs outstanding soared to RMB7.1trn by end-2012, equivalent to 7.4% of bank deposits. There are several reasons to be concerned in this area. Maturity mismatch. WMPs are predominantly short-term instruments, with an average maturity of less than 1yr (Figure 35). Yet some of the funds raised have been utilised in long-term projects, such as infrastructure and property projects. To keep the maturity mismatch problem at bay, banks have to constantly issue new WMPs to fill the gap left by expiring ones. A lack of transparency. A common practice at commercial banks in operating WMPs is through the fund pools mechanism, where a bank issues a series of WMPs and puts the funds into a pool to finance a large number of projects. The projects and the WMPs are not matched bilaterally, and so it is impossible to clearly identify the risk of any given WMP.
a maturity mismatch Banks face risks from three dimensions: 1) Loans to LGFVs

2) loans to property developers

3) wealth-management products, which suffer from

a lack of transparency

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The CBRC has asked banks to clean up the fund pools and match WMPs with specific projects. Links to risky assets. Many WMPs are linked to stocks, bonds and exchange rates (Figure 36). About 36% of WMPs are reportedly related to trusts (Figure 37). As we discuss below, trust products may well be the weakest link in the financial leverage chain. The boom of WMPs has only happened in the past several years and has not been tested by a downturn in the credit cycle so far there have only been a limited number of default cases in the trust sector, but we believe the likelihood is high that there will be more in the years ahead.
and often have links to risky assets, such as trusts

In theory, WMPs do not add credit risk to the banks, as information is disclosed so that investors can judge their investment risk. In reality, however, there may be implicit credit risk for the banks. A very recent example involving Huaxia Bank demonstrates this after an employee sold a WMP which subsequently defaulted. It was discovered that the salesman was not authorized by the bank to sell it and many investors then claimed that this was fraud and demanded Huaxia Bank pay for their losses. The losses were eventually paid, though the source of the funds was not clear. Nonetheless, this example illustrates that it is not 100% clear whether the banks can walk away from credit risk related to WMPs. In the case of default, there is every chance that investors will become embroiled in lengthy disputes with the bank that sold them the product. Another significant loan category amounting to RMB8.2trn, or 13.1% of total loans outstanding is mortgage lending (Figure 38). However, we believe mortgage loans do not constitute a major risk to banks because: 1) down-payment requirements are high 30% for first-time homebuyers, 60% for a second house, while mortgages are not an option for third houses or more; 2) 30% of mortgage loans were made before 2009, when housing prices were 33% lower than current levels. Therefore, even if housing prices were to fall sharply, by say 30%, the net impact on bank mortgage loans would not be too significant.

WMPs may expose banks to heightened credit risks

Household mortgage loans do not constitute a major problem for banks

Fig. 33: Breakdown of bank loans

Fig. 34: NPL ratio of major commercial banks

%
LGFVs
16 14

RMB9.3trn Others RMB40.5trn

Mortgages

12 10

RMB7.9trn
8

RMB3.8trn

6
4

Property developers

2 0 Dec-04

Dec-06

Dec-08

Dec-10

Dec-12

Note: Data is for Q3 2012. Source: CEIC and Nomura Global Economics.

Source: CEIC and Nomura Global Economics estimates.

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Fig. 35: WMP issuance by tenor


Unit issued 20000 Undisclosed above 24m 6-12m 1-3m

Fig. 36: WMP issuance by asset base


Unit issued 20000 Undisclosed Other Credit Rates Bond

16000

12-24m 3-6m

16000

Commodity FX Stock Mix

12000

1m

12000

8000

8000

4000

4000

0
1H05 2H05 1H06 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10 1H11 1H12 2H12
2H11

2013*

0
1H05 2H05 1H06 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10 1H11 1H12 2H12
2H11

Note: 2013 data refers to new issuance in January and February. Source: WIND and Nomura Global Economics.

Note: 2013 data refers to new issuance by January and February. Source: WIND and Nomura Global Economics.

Fig. 37: WMP issuance by investment channel


Unit issued 20000

Fig. 38: Breakdown of mortgage lending


Mortgages issued before 2009

16000
QDII 12000 Trust Others

Mortgages issued after tightening (2011-12)

30%

8000

55% 15%

4000

0
1H05 2H05 1H06 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10 2H10 1H11 1H12 2H12
2H11

2013*

Mortgages issued before tightening (2009-10)

Note: 2013 data refers to new issuance by January and February. Source: WIND and Nomura Global Economics.

Source: WIND and Nomura Global Economics.

Trust companies and credit guarantee companies


Trust companies and credit guarantee companies face, and also pose, high risks. Their business model has only flourished in recent years as the government has tightened controls on bank lending, restricting their exposure to LGFVs and property developers. However, with access to bank loans curbed, LGFVs and developers simply turned to the bond market and trust companies for financing. Tapping the bond market requires a credit rating and more detailed disclosure, such that borrowers with lower credit quality were more likely to look to the trust companies for financing, while having credit guarantee companies (CGCs) helps lower their borrowing costs. The trust companies quickly became the second-largest group of non-bank financial institutions in terms of assets under management (AUM) (Figure 39). In 2008, AUM for the sector was only RMB1.2trn, smaller than the insurance sector (RMB3.3trn) and mutual funds (RMB2.6trn). By 2012, this AUM had rocketed to RMB7trn, exceeding both the insurance (RMB6.9trn) and mutual fund (RMB2.9trn) sectors.
Trust and credit guarantee companies face high risks

AUM at the trust companies rose by 5.8x in five years it is bigger than the insurance sector

19

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As mentioned before, property and infrastructure projects are the main destinations for funds raised from trust companies (Figure 40). Official data show that in 2012 around 8% of trust funds went to property investment, 28% to infrastructure and 35% to industrial and commercial companies. Information is not provided on where the remaining funds are invested. We think a large part of it may have gone to property-related projects as well. The business of trust companies in China is highly cyclical. Indeed, trust companies have always been utilised as a channel of alternative financing banks are traditionally heavily regulated, yet trust companies could work through loopholes in the system to offer credit supply to money-hungry firms that do not have access to banks. In that sense, trust companies in China work exactly as shadow banks. History suggests we need to be very cautious about the boom in the trust sector There have been five boom-and-bust cycles in the trust sector since 1980. Each time the boom was associated with an economic upturn and the bust amplified the deleveraging process and damaged the economy (see Appendix 1).
Fig. 39: Assets under management at non-bank financial sectors
RMB bn 7,000 Mutual funds

Property and infrastructure projects are popular trust investments

The trust sector is highly cyclical and typical of the shadow banking sector

Five cycles that suggest a trust sector boom usually leads to a bust

Fig. 40: Investment channel of trust products


Securities Market, Financial Inst & others Infrastructure Real Estate Industrial & Commercial Enterprise

RMB bn 1,400
Insurance Trust

6,000
5,000 4,000 3,000 2,000 1,000

1,200 1,000 800 600 400 200 0 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

0
2007 2008 2009 2010 2011 2012

Source: Media reports, CEIC and Nomura Global Economics.

Source: CEIC and Nomura Global Economics. The current boom may be close to its end

We believe Chinas trust sector is going through its sixth boom-bust cycle with the end of the boom nearing. The trust companies have received a lot of negative press coverage since mid2012 (see Appendix 2), with reports that many trust products were close to default yet they have managed to somehow survive. When monetary policy and regulations on trust companies tighten, the risks in this sector will eventually emerge and may be difficult for local governments to contain. CGCs also face high risks if the economic cycle turns down. These are also not well regulated and many are reportedly engaged in underground lending. There were several high-profile fraud cases reported in 2011 and 2012 in this sector, including the case of Zhong Dan, which was one of the top private CGCs in China. In May 2012, it went into bankruptcy as its owner disappeared with his clients' money after reportedly running a heavily leveraged business empire that ran into trouble once monetary policy was tightened early in the year. The total loss to clients was RMB1.3bn. The CGCs are not transparent and there is very limited information about the current state of this sector, but the Zhong Dan case suggests they may be subject to high credit risks in the next round of policy tightening.

Some CGCs defaulted when policy was tightened in 2012

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Household sector
China's household sector is in good financial condition, with total household debt at only RMB10.4trn at end-2012, or 20.1% of GDP. Mortgage loans outstanding were RMB8.1trn, or 15.6% of GDP (Figure 41). The low leverage of the household sector is in large part because of stringent requirements on down-payments and a relatively low mortgage rate, as well as policy tightening in the property sector in recent years. A household borrowing culture has only recently started to take hold. The household saving rate remains high, and home ownership is high as well. The household sector has so far proven rather resilient to equity price shocks. The Shanghai A share index plunged from 5,954 in 2007 to 1,820 in 2008, yet retail sales growth remained solid at 21.6% in 2008 from 16.8 in 2007 (Figure 42). Low leverage in the household sector must in large part be recognised as a significant factor in the muted reaction. Financial market liberalisation has led to some new risks to household balance sheets, but we believe they are manageable. We estimate the total amount of corporate bonds and trust products outstanding by the end of 2012 was RMB8.5trn, with most held by financial institutions rather than household. Moreover, total household deposits are RMB41.1trn. Combined with limited leverage, we therefore believe the impact of a potential default on household balance sheets would be manageable.
The household sector is in good financial condition

Low household leverage means consumption has been resilient to equity price shocks

A bond market default is unlikely to affect the household sector significantly

Fig. 41: Household debt

Fig. 42: Retail sales growth and Shanghai Stock Index

% of GDP
24 Mortgage loans 20 Total household debt 16

% y-o-y
23

Retail sales, lhs

Dec 1990 =100 7,000

SHCOMP Index, rhs

21

5,800

19

4,600

12

17

3,400

15

2,200

4 2002 2004 2006 2008 2010 2012

13 Dec-06

Jun-07

Dec-07

Jun-08

1,000 Dec-08

Source: CEIC and Nomura Global Economics.

Source: CEIC and Nomura Global Economics.

Corporate sector
Property developers are also leveraging up. There are two sources of data on property developers' financial conditions: the financial reports of listed companies, which show the debtto-asset ratio had risen to 71% by 2012, from 40% in 2009 (Figure 43). The other is data from the National Bureau of Statistics (NBS) data on the source of funds for property investment by all property developers, which shows that they rely increasingly heavily on funding from outside the banks (Figure 44). We believe the risks to property developers and LGFVs are tied together. If the property market cools, developers would be expected to shy away from land sales and the LGFVs would face severe financing problems. Actually, some LGFVs are property developers themselves. For instance, in Changzhou, the Wujin Urban Construction Company owns a property developer which contributes most of the funding to its infrastructure projects. Leverage conditions in the overall industrial sector seem stable, as the debt-to-asset ratio remains around 58% in recent years. However, it is worth noting that profitability has fallen in recent years, which shows that they may be becoming more vulnerable to a shock.
Property developers face risks given their high leverage

Risks of property developers and LGFVs are tied together

Leverage of the whole industrial sector is stable, but profitability has fallen

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Fig. 43: Debt-to-asset ratio of listed property developers

Fig. 44: Property developers dependence on non-bank loan funding


% of total 85

% of asset 80 70

83

60
50 40
81

30
20

79

77

10

0
2009 2010 2011 2012

75 1997 2000 2003 2006 2009 2012

Source: Bloomberg and Nomura Global Economics.

Source: CEIC and Nomura Global Economics.

The linkage of risks and moral hazard


From a macro perspective, risks to the financial sector, local governments and property developers are well linked. The root of the risk is the decline of potential growth and the governments efforts to maintain high growth amid the global financial crisis and political transition. This has lead to a heavy reliance on infrastructure investment and loose monetary and fiscal policies since 2008. A large part of the financing burden of infrastructure investments has fallen on local governments who had no choice but to resort to land sales and LGFV bond issuance. Loose monetary policy has led to a rapid rise in land and property prices, which helped local governments finance their investments in the short term. In the longer term, though, the current model is unsustainable, as local government financing needs to grow faster than revenue. Regulators tried to contain the risks in the banking sector, but they tolerated the boom of shadow banking activity to feed the financing needs of local governments and property developers. It is important to note that the implicit government support of shadow banking activity was critical to the rapid growth in this sector. Trust products to LGFVs often sell out quickly, although the promised returns sound too good to be true, largely because investors assumed there is little credit risk given the borrowers ties to government. This perceived government guarantee introduces a significant moral hazard problem in the financial market. Indeed, local governments have even been known to bail out private companies to avoid a default in their jurisdiction. For instance, when Saiwei, a major solar panel producer, faced trouble paying its bonds, the city government of Xinyu in Jiangxi Province (where Saiwei is located), used public funds to pay the bonds and avoid default. The story was widely reported in the Chinese-language financial press and made investors believe corporate bonds in general faced little credit risk. The moral hazard problem is not helped by the rating agencies. The IMF reported that 97% of corporate bonds in China were rated AA or higher (IMF, GFSR, October 2012). The moral hazard problem not only leads to financial risks, but also worsens income inequality. As many shadow banking products are only open to high net worth retail investors (minimum subscription for trust products is usually RMB1m- 3m), only the rich can take advantage of the implicit government guarantee, while the government will likely have to pick up losses, at least from LGFV-related investments using funds that ultimately come from the general public. The boom in shadow banking and the severe moral hazard problem essentially lead to wealth transfer from the poor to the rich.
Risks of property developers, LGFVs and the financial sector are interlinked

Government support leads to severe moral hazard

The 2012 bailout made investors believe credit risk is limited

The moral hazard issue leads to a transfer of wealth from the general public to the rich

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Endgame: Base case and risk scenario


Base case
Our base case is that the government will tighten policies to contain financial risks in 2013. We expect the government to gradually bring down growth of M2 money supply and total social financing as early as from Q2 2013, to tighten controls on shadow-banking activities and LGFV financing, and to hike interest rates twice in H2 2013. The cost of the tightening is that we estimate economic growth to slow to 7.3% y-o-y in H2 from 8.1% in H1. The benefit is that China should be able to reduce the risks of a systemic financial crisis and avoid a much harder economic landing beyond 2013. The government has started to signal that it is concerned with financial risks and plans to take actions to contain them. These signals have not yet turned into concrete action monetary policy remains loose as TSF hit an all-time high in January and remained strong in February on a working-day adjusted basis. M2 growth stood at 15.2% y-o-y in February compared to 13.8% in December. Still, we continue to believe that policy will eventually be tightened, as the government announced on 5 March to target M2 growth at 13% in 2013, from 14% in 2012. Investors may wonder why we believe proactive policy tightening is possible in the first year of the new Politburo leadership. The consensus view is for a sustained recovery throughout 2013, exactly because of the political argument new leaders always have an incentive to push up growth when they take over, hence policy will maintain its easing bias for 2013 and even 2014, with GDP growth staying above 8% for both years. We believe the consensus view is wrong for four reasons. First, it underestimates the challenges facing the new leadership. The risks we have identified in this report have been well-flagged by international organisations as well as domestic leaders and researchers. We believe the new leadership understands that it is in the best interests of the nation and their own best interests to handle the risks early in their 10-year tenure. They have the capacity to keep the investment boom in the property and infrastructure sectors going for a year or two by keeping policies loose, but eventually the problem will become bigger and harder to resolve. Second, the leadership has the advantage of hindsight and can learn from other countries experiences. We believe they can learn a lot from the lessons of Japan and Germany in the 1980s, when both countries experienced rapid economic growth, but Japan experienced an asset price bubble that burst and led to its lost decade, while Germany maintained strong growth without a major crisis. One key difference is that the German central bank adopted a prudent monetary policy such that the leverage ratio of the economy did not rise sharply, as it did in Japan (Figure 45). This is a clear lesson for China that it should control its leverage to help avoid systemic financial risks. Recent experience does show that lessons have been learned. When the government rolled out policies to cool the property market in 2010, there was also a widespread view that the measures would only be temporary, but actions over the past three years demonstrate the governments clear awareness of how dangerous a property bubble can be, and how determined it is to handle the risk. We believe the government is far-sighted and will react decisively to risks that challenge sustainable growth, even if reacting comes at a cost to shortterm growth. Third, we believe the government understands that a failure to tighten policy now will become much more costly in the future. With the labour market remaining tight in 2012, despite the economy slowing to 7.8% growth, there was no widespread social complaint over slower growth. We believe the Chinese leaders recognise that the key problem now facing China is no longer maintaining high growth at around 8%, as unemployment is no longer a big issue. The main risks are now financial stability, inflation and a property bubble. Slower growth will help to address these problems, and as such, can be tolerated. Lastly, we expect inflation to rise above the government target of 3.5% by mid-2013, forcing the PBoC to hike interest rates twice by a total of 50bp in H2. Inflation is the ultimate constraint on how long the government can afford to keep a loose policy bias. Recent data show inflation is already rising.
We expect the government to contain financial risks via policy tightening

The government has signalled its concerns recently

Consensus believes the new government has to keep policy loose in its first year

We believe the government will tighten because: 1) the risks are high

2) The government may apply lessons learned from other countries failure

as it showed in tightening its property sector policies

3) Delayed policy tightening will incur higher costs in the future

4) Inflation will eventually force tighter policy

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We believe that if the government decides to tighten policy quickly, a few cases of default are likely, but the banks and the government have the capacity to absorb these losses. The question becomes one of burden sharing among the government, the financial sector and investors, but we see little risk of a systemic financial crisis.

We believe policy tightening in 2013 will not lead to a systemic crisis

Risk scenario
The risk scenario is that the government decides to keep policy loose and tolerate the financial risks in exchange for strong growth in the short term. This is clearly a dangerous choice, but we cannot rule it out given political pressures to maintain strong growth. We acknowledge the fact that this is the first year for the new leaders in office, and that at the recent National Peoples Congress it was decided to keep a growth target of 7.5% rather than cutting it to 7% (the target for the 2011-15 five-year plan). When growth slows to 7.5% or below, we can expect a lot of pressure to loosen policy and deliver another round of fiscal stimulus. If the government does decide to loosen policy further this year, then the risks of a systemic crisis in coming years would rise. We have written before on the risk of an economic hardlanding (see China risks, November 2011), while our proprietary China Stress Index suggests elevated macro risks in the economy (see Nomura's China Stress Index (CSI) - high but stable in Q4, 31 January 2013; Figure 46). Further policy easing could push the leverage ratio and inflation even higher, which would make the eventual deleveraging process more disruptive.
Fig. 45: Domestic credit-to-GDP ratio, Germany and Japan
% of GDP 135 Germany Japan, rhs 101.5 125 235 101.0 115 210 100.5 105 185 100.0 % of GDP 260

The risk scenario is if policy remains loose

in which case systemic risks can be expected to rise

Fig. 46: Nomuras China Stress Index (CSI)


Jan 2000 =100

102.0

China risks report published

95 1980 1982 1984 1986 1988 1990 1992

160

99.5 Dec-00

Dec-03

Dec-06

Dec-09

Dec-12

Source: IMF, CEIC and Nomura Global Economics.

Source: IMF, CEIC, WIND and Nomura Global Economics.

In a systemic crisis scenario, we believe the first link in the system to break would be the credit guarantee companies, the trust companies and the highly leveraged developers without government ties. CGCs and trust companies are highly leveraged, as they have only a limited amount of capital. Once a default occurs in the bond and/or trust market, credit spreads could widen to price in the actual risk premium and we can expect the volume of transactions to shrink quickly. Contagion could quickly spread because many of the risks have become interlinked. It would be difficult for firms to issue new debt without an explicit government guarantee. Without government intervention, the risks would inevitably spread to the banks and the corporate sector. The banks NPL ratios are generally low, partly because the LGFVs had to borrow from the bond and trust markets to repay bank loans. If LGFVs can no longer issue new debt, then NPLs at the banks would likely rise. The same argument applies to the corporate sector as well, particularly the property developers. That said, we doubt the government would allow the shock to be amplified through the above channel, so in this case, we believe a public bailout would be an inevitable eventuality. A bailout on such a scale is not unprecedented in China. In the early 2000s, the government set up four asset management companies (AMCs) and transferred the bad loans from bank balance sheets to them. The operation was financed through the Ministry of Finance. The AMCs still exist and could play an important role in this risk scenario.

CGCs, trust companies and highly leveraged property developers are at most risk

Banks would be affected without government intervention

The government would likely bail out the financial sector, as it has in the past

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Of course, there are many forms that a bailout could take. The conventional debt restructuring or debt writedown of bank NPLs, in which investors (including the government as major shareholder) would have to bear the loss. The injection of public funds to recapitalise the banks and transfer NPLs to the AMCs at a discounted price, similar to events in the early 2000s, is also an option. Third, is a potential transfer of central government funds to local governments as a source to allow them to repay their debt, or, fourth, the sale and privatisation of local government assets to repay the debt. We do not have a particularly strong view on which particular option would be the primary model, but we do see an increased likelihood of greater privatisation in the years to come. Many local governments own assets in areas such as public utilities, highways and housing, many of which are the result of fiscal largesse in recent years. It is not hard to imagine local governments being forced to sell such assets at discounted prices as pressure builds. While a bailout could help avoid a complete financial sector meltdown, it would not be enough to kick-start the next growth cycle. In the early 2000s, Chinas economy turned around not because of the bailout, but because of a series of aggressive reforms alongside WTO accession; the high potential for productivity growth given favourable demographic trends; and a huge labour force that migrated to the coastal regions to work. The key to Chinas future is reform, which usually only happens when the pressure to act has built to intense levels. Privatisation at both the state and local level may also help improve productivity. The government may even be forced into other tough reform decisions, such as de facto land privatisation. The economic outlook will depend on how these reforms are conducted, and the end-game will plant the seeds of the next phase of economic development.

A bailout could take many forms

A bailout may be funded by selling state-owned assets

A crisis may trigger reforms, as has happened in the past

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Appendices
Appendix 1: Five rounds of trust company regulation
Round 1: 1985. In 1977 Deng Xiaoping took over the political leadership and began his famous market-oriented reforms. The establishment of China International Trust and Investment Corporation (CITIC) in October 1979 marked the re-emergence of the trust industry in China. Over 1981-82, many new trust companies were established by banks, local governments and government ministries, but their main business was to take deposits or enable interbank lending, either for lending or direct investment in development projects. However, the practice quickly led to an overheating in fixed asset investment and rising inflation. The State Council tightened regulations on the trust industry in September 1985, banning new trust loans and cleaned up existing trust loans. Round 2: 1988. The economic cycle picked up in 1986 and ended in 1988 when the economy overheated. Fixed asset investment growth reached 25.4% and hyper-inflation surged to 20% from 7.8% in 1987. By early 1988, the number of trust companies had increased to around 1,000, of which 745 had received formal approval from the Peoples Bank of China. In August the government controls reduced the number of trust companies to 360. Round 3: June 1993. The economy overheated once more following Deng Xiaopings famous south tour in 1992. One important regulation was the separation of trust and banking businesses. Trust companies were banned from deposit-taking or conducting settlement business and were also excluded from the securities brokerage and underwriting businesses. Round 4: 1998. The financial crisis in East Asia led to a growth slowdown in China and some high profile bankruptcy cases such as Guangdong International Trust Company (GITIC). By 2001, the number of trust companies had fallen to just 59. Round 5: 2007. Amid another period of economic overheating, these were partly triggered by several bankruptcy cases in the trust sector between 2004 and 2006, such as DLong Company and Hainan Huitong Trust and Investment Corporation. In March 2007, the regulators announced that they would apply ratings-based regulations on the trust industry.
Source: Nomura Global Economics.

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Appendix 2: Trust companies have grabbed the headlines

Media reports Feb 2012 Mar 2012 May 2012 June 2012 Sep 2012 Nov 2012 Nov 2012 Dec 2012

Risk event SDIC Trust arranged a trust loan of RMB200mn to a company with no income or tax record, and with poor collateral. Jilin Province Trust suffered a loss from a fraud related to one of its trusts worth RMB150mn. Local government in Shandong reportedly asked trust companies to issue trust products for government financing. China Credit Trust's RMB3.0bn mineral energy trust product reportedly faced a high default risk. Zhong Rong International Trust's RMB1.164bn of products related to real estate projects in Ordos faced a high default risk. China Fortune International Trust failed to pay interest on its RMB547mn of trust products. A trust product sold by Huaxia Bank defaulted, which was widely reported in both Chinese and international media. CITIC Trust's RMB1.3bn San Xia Quan Tong Project faced high default risks and failed to make interest payments on time. Qingdao Kaiyue, a RMB300mn trust loan product originated by Zhong Rong International Trust, had difficulty paying investors. The collateral (real estate assets) was auctioned at 60% below the original appraised price. Chaorisolar, a listed solar power company, pledged its equity to eight trust companies. It faces the risk of bankcruptcy and the CEO has disappeared. Trust loans linked to the company face default risks. Pingan Trust's RMB3.6bn project "Jiayuan #25" faces heightened default risk as its Fuzhou property project is far from completion, but the trust repayment date is close. The RMB400mn "golden bull" trust product issued by CCB Trust reportedly suffered a book loss of over 50%. CITIC Trust's RMB710mn real estate project in Qingdao faces a high default risk. The collateral (real estate assets) was auctioned at 40% below the original appraised price Xinhua Trust announced one of its trust loans faces default risks, as the guarantor, Gaoyuan Real Estates, is stuck in a debt crisis. CITIC Trust's RMB1.3bn San Xia Quan Tong Project failed to pay interest on time Tianjin Trust's one trust product was was terminated prematurely in February, less than three months from its issurance, due to interorganizational disputes. An Xin Trust announced a sharp decline in net profit attitributed to shareholders, down by 44.8% from RMB195mn in 2011 to RMB108bn in 2012. The trust product named Chuang FU, issued by Ping'an Trust, was reported to have suffered a loss close to 30%.

Dec 2012

Dec 2012

Dec 2012 Dec 2012 Jan 2013 Jan 2013 Jan 2013 Feb 2013 Mar 2013 Mar 2013

Source: Various media sources; Nomura Global Economics.

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Appendix 3: Forecast summary

% y-o-y growth unless otherwise stated Real GDP Consumer prices Core CPI Retail sales (nominal) Fixed-asset investment (nominal, ytd) Industrial production (real) Exports (value) Imports (value) Trade surplus (US$bn) Current account (% of GDP) Fiscal balance (% of GDP) New increased RMB loans (CNY trn) 1-yr bank lending rate (%) 1-yr bank deposit rate (%) Reserve requirement ratio (%) Exchange rate (CNY/USD)

1Q12 8.1 3.8 1.5 14.9 20.9 11.6 7.6 6.9 0.2

2Q12 7.6 2.9 1.3 13.9 20.4 9.5 10.4 6.4 68.4

3Q12 7.4 1.9 1.5 13.5 20.5 9.1 4.4 1.4 79.2

4Q12 7.9 2.1 1.5 14.9 20.6 10.0 9.5 2.8 83.4

1Q13 8.2 2.7 2.0 16.2 21.0 10.8 3.0 7.0 -16.9

2Q13 8.0 3.4 2.1 15.9 21.2 10.5 4.0 8.0 52.9

3Q13 7.4 3.6 2.4 15.5 21.3 9.6 6.0 9.0 70.1

4Q13 7.2 4.5 2.1 15.6 22.0 9.6 6.0 9.0 74.3

2012 7.8 2.6 1.5 14.2 20.6 10.1 7.9 4.4 231.2 2.6 -1.6 8.2 6.00 3.00 20.0 6.29

2013 7.7 3.5 2.2 15.8 22.0 10.1

2014 7.5 4.0 2.0 16.0 20.0 9.7

4.9 6.0 8.3 10.0 180.3 122.0 1.0 -0.4 -1.5 -1.6 9.0 6.50 3.50 20.0 6.15 9.0 6.50 3.50 19.0 6.14

6.56 3.50 20.5 6.31

6.31 3.25 20.0 6.32

6.00 3.00 20.0 6.34

6.00 3.00 20.0 6.29

6.00 3.00 20.0 6.22

6.00 3.00 20.0 6.18

6.25 3.25 20.0 6.16

6.50 3.50 20.0 6.15

Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 15 March 2013. Source: CEIC and Nomura Global Economics.

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References
Martin Neil Baily, Productivity and potential growth in the US and Europe, January 2008, presentation at the European Central Bank. Claudio Borio and Mathias Drehmann (March 2009), Assessing the risk of banking crises revisited, BIS Quarterly Review, p. 25-46. David Brackfield and Joaquim Oliveira Martins, Productivity and the crisis: Revisiting the fundamentals, 11 July 2009. Yongheng Deng, Jing Wu and Hongyu Liu (2013, forthcoming), House Price Index Construction in the Nascent housing market: The Case of China, Journal of Real Estate Finance and Economics. Yongheng Deng, Joseph Gyourko and Jing Wu (September 2012), Land and House Price Measurement in China, NBER Working Paper No. 18403. Federal Reserve Bank of Atlanta, The role of external shocks in the Asian financial crisis, Economic Review, Q2 1999. Jeffrey Frankel and George Saravelos (2011), Can Leading Indicators Assess Country Vulnerability? Evidence from the 2008-09 Global Financial Crisis, Regulatory Policy Program Working Paper RPP-2011-02. Robert J. Gordon, The Slowest Potential Output Growth in U. S. History: Measurement and Interpretation, presented at the Center for the Study of Innovation and Productivity at the Federal Reserve Bank of San Francisco, 2008. Pablo Hernndez de Cos, Mario Izquierdo and Alberto Urtasun, An estimate of the potential growth of the Spanish Economy, Banco de Espana Documentos Ocasionales, N 1104, 2011. Richard C. Koo (14 October 2012), Balance Sheet Recession as the Other-Half of Macroeconomics, Nomura Research Institute. Yang Li, Zhang Xiaojing et al. (June 2012), Chinas Sovereign Balance Sheet and Its Risk Assessment, Economic Research Journal, p. 4-19. Kalina Manova and Zhiwei Zhang (2012), Export Prices across Firms and Destinations, Quarterly Journal of Economics 127 (2012), p.379-436. Xiao Gang (12 October 2012), Regulating shadow banking, China Daily. Zhiwei Zhang (November 2001), Speculative Attaches in the Asia Crisis, IMF Working Paper Series, WP/01/189.

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Recent Asia Special Reports


Date 6-Mar-13 28-Nov-12 14-Nov-12 25-Oct-12 11-Oct-12 24-Sep-12 14-Sep-12 5-Sep-12 3-Sep-12 7-Aug-12 2-Aug-12 31-Jul-12 9-Jul-12 31-May-12 29-May-12 2-May-12 23-Apr-12 16-Apr-12 11-Apr-12 27-Mar-12 9-Mar-12 1-Mar-12 23-Feb-12 16-Jan-12 20-Dec-11 18-Nov-11 3-Nov-11 31-Oct-11 19-Oct-11 21-Sep-11 8-Aug-11 7-Jun-11 10-Mar-11 3-Mar-11 14-Jan-11 1-Nov-10 11-Sep-10 6-Aug-10 28-May-10 26-May-10 9-Nov-09 Report Title Southeast Asia: Different strokes 2013 Outlook: Asia's overheating risks South Korea: An Economic Democracy India reforms (Part I): A long way to go Introducing NESII The Nomura Economic Surprise Index for India Thailand: New growth engines China primed to surprise on the upside Better hedges for a China hard landing India's chronic balance of payments Asia's inflation wildcard Indonesia: Policy swings India: A poor monsoon and its impact (Q&A) South Korea: Prolonged low growth, inflation and rates through 2013 Pan-Asia: Inventory cycle threatens a slow recovery China's peaking FX reserves India: Make or break The China compass Korea: Uncomfortable trade-off India: Four cyclical tailwinds to watch Capital account liberalisation in China India budget preview: Fiscal cheer Asia: What if oil prices keep rising? Philippines Fiscal space to maneuver Decoding Indias stubbornly high inflation Implications from North Korea A cold winter in China Thailand: Dealing with another disaster China Risks Korea: Falling, converging bond yields China: The case for structurally higher inflation Global market turbulence: Implications for Asia Indonesia: Building momentum Vietnam: Prioritizing macro stability South Koreas demographic sweet spot India's 2011 outlook: Rising symptoms of a supply-constrained economy The case for capital controls in Asia The coming surge in food prices Another step towards becoming an offshore RMB centre The heat is on Brinkmanship returns to the Korean peninsula China: Not just an investment boom

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