Cheap money in CHINA Risky?

In China, low interest rates have led to an explosion of Chinese hard-currency assets: Reserves grew by $210 billion in 2004 to $610 billion, giving the country the world's second-largest foreign currency reserve after Japan. But that still hasn't kept China's money supply from growing by 14% in the 12 months ending February 2005. That's an improvement from the 18.4% in the 12 months ended in February 2004.Nor is China an isolated case. In India, money supply grew at an annualized rate of 12.8% in the period that ended on March 4. The cheap-money cycle has had powerful positive effects on global economies. For example, India's GDP grew by 7% in the fiscal year that ended in March 2005, after recording 8.5% growth in fiscal 2004. China's State Information Center projects that its economy will grow at an annualized 8.8% in the first quarter of 2005, after growing by 9.5% in the fourth quarter of 2004. By comparison, the U.S. economy grew at an annualized 3.8% in the fourth quarter of 2004.
So what's the problem? Well, companies and individuals loaded up on goods because money was so cheap, and they will be hard-pressed to make payments when interest rates climb. The less developed a country's financial markets are, the larger the damage is likely to be in any shift from a cheap-money cycle to a less-cheap-money cycle.
In the U.S., where credit-card companies, banks and credit bureaus run sophisticated data collection and crunching operations, the turn is likely to produce a bump up in consumer defaults that will catch some badly run financial institutions by surprise. If the transition from one cycle to the other is abrupt enough, the result can even be the kind of massive default among financial institutions that characterized the savings-and-loan crisis of the late 1980s and early 1990s. That debacle cost U.S. taxpayers somewhere north of $300 billion.
The damage has the potential to be much worse in a country such as China, where the financial markets are still very much works in progress. Consider this example: According to the official Xinhua News Agency, China's local governments owe $50 billion (at official exchange rates), or about 15% of the country's total fiscal revenue in 2004. That figure is likely to be low, an official audit has concluded, but even that total exceeds the repayment capabilities of China's local governments. How did local governments get in such a fix when Chinese law prevents local governments from borrowing from banks? They evaded the law by borrowing from intermediaries set up specifically to secure bank loans for investments in local infrastructure.
Nobody knows exactly how big the bad loan problem is. Nonperforming loans (a very subjective category in China) at Chinese banks total at least $200 billion. I say "at least" because a company owned by the People's Bank of China, the Chinese central bank, has injected $45 billion in capital into just two of the country's biggest banks, China Construction Bank and Bank of China, to clean up bad loans in preparation for an initial public offering and overseas stock-market listing for the two banks.Hey, sign me up for those two deals.And finally this: Despite sometimes rudimentary risk-control systems, China's financial institutions are up to date in one area -- they're willing to play in the derivatives market with the big boys of Wall Street. Last November, China Aviation Oil, a jet-fuel importer listed on the Singapore market but backed by the Chinese government, sought protection from creditors after it ran up $500 million in losses in derivatives after betting that oil prices would fall. In China, just as in the U.S., nobody really knows the details of any financial institution's exposure to the derivatives market. In China, however, due to the immaturity of the financial system, it is much more difficult than in the U.S. to figure out where the risk in any derivative trade will actually come home to roost.
The more abrupt the transition from a cheap-money to a less-cheap-money cycle -- and the faster interest rates rise -- the slower global economic growth in general. And, also, the higher the risk of a country-specific financial crisis in the financial markets of these key countries in the developing world.