The Financial Times on China's Financial Frailties

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From Financial frailties might slow China’s growth:

Nevertheless, the threat represented by China’s two biggest financial frailties dwarfs any positive influence that may flow from the over-hyped expectations of renminbi appreciation.
According to China Confidential research into local government finance companies (LGFVs), as much as Rmb 2,000bn ($294bn) of the Rmb 7,380bn in outstanding loans to LGFVs at the end of 2009 may turn out to be problematic – and those problems may start to surface as early as the second half of this year.
Adding to these risks, China’s unregulated underground banking system appears to be booming as savers frustrated with negative real deposit rates remove their money from banks and place it with shadowy money lenders offering interest rates that typically range between 90 per cent and 150 per cent annually – compared to the official benchmark 2.25 per cent annual deposit rate. One senior city official described such curb-side banking as “chaotic”.

The confluence of these two frailties could have significant implications. We think that loan growth – the main driver of the economy in 2009 – could start to slow significantly in the second half of the year as financial regulators tackle LGFV debt problems and other risks in the financial system.
The predicted slowdown in lending, coupled with indications that fixed asset investment, the real estate market, auto sales and manufacturing growth are also moderating, could produce year-on-year a GDP growth rate in the second half that is a few percentage points lower than the 11.9 per cent recorded in the first quarter.
An examination of the detail lends credence to the slowdown scenario. The State Council (cabinet) in mid June ordered that bank loans to LGFVs should not be guaranteed by fiscal revenues or assets owned by local governments such as equity in state-owned enterprises. Instead, the loans should be serviced by operating revenues from the projects that used the loans. However, only an estimated 40 per cent of loans to LGFVs can be serviced by operating revenues in this way – the rest rely on the proceeds of local land sales, fiscal revenues, dividends from local state enterprises and other inflows into local coffers.

Read the original story at Israel’s Financial Expert