China’s year of living dangerously
China's bailout of a trust product during January likely defended economic growth but perpetuated the moral hazard in a country with a zero-default policy.
Balancing stability and reform will become even harder as the year progresses; the bill from China's post global financial crisis stimulus binge is falling due and money-market rates have surged since last June.
The troubled trust product, with an exposure of about $500 million to a Chinese coal mine, was sold nationally by one of the world's biggest banks ICBC. The moral hazard is the implicit guarantee that investors in banks' bundles of wealth management products will be made whole whatever happens by state-backed lenders.
It is unclear who bailed out the trust fund, whose biggest shareholders are state-owned enterprises, but they only succeeded in pushing principal repayment further down the road.
Financial stress will grow this year as the under-regulated shadow banking system, of which trusts are a big part, looms ever larger and the central government cracks down on credit growth. Analysts estimate $874 billion in trust products will mature this year, up 50% year-on-year.
Global investors' worries about China's monetary tightening prompted wider emerging market distress in February, although to a lesser extent than Federal Reserve policy.
Financial institutions have failed before in China but work-outs using tax-payer funds meant the principal was eventually repaid.
A principal default where investors lose their shirts would force markets to price risk correctly on the other hand avoiding a major default held back knock-on effects difficult to imagine. One analyst likened it to a Bear Stearns moment.
The message from China's leaders seems clear growth first, reform second.
Alison Tudor-Ackroyd, editor