Evergreen Lending with Chinese Characteristics

Aug 10, 2023

In my “Lessons of Japan” seminar at Yale, I placed considerable emphasis on the role played by evergreen bank lending as a key feature of the “lost decade” syndrome. The concept was examined carefully in a seminal piece of research by Joe Peek and Eric Rosengren. By evergreening, they referred to government-supported bank financing of distressed borrowers that enabled them to cover interest payments on underwater loans, thereby avoiding the stigma of nonperforming loans. Such forbearance had the effect of directing credit to Japan’s growing profusion of corporate zombies, perpetuating a misallocation of credit that exacerbated weak productivity and deepened the Japanese quagmire of stagnation and deflation.

There are early signs that China could be making a similar mistake. In a July 23 meeting of the Chinese Politburo, the Party’s leading policy group clearly flinched when it addressed the long-distressed property sector. For the past several years, in keeping with mounting Japanization concerns, the deleveraging campaign had been steadfast in focusing on the excesses in this sector. But now with the recovery in the aggregate economy in jeopardy, it is backing off. The official statement following the latest Politburo meeting made no mention of the statement that “housing is for living, not for speculation”—Xi Jinping’s clarion call for action since 2017.  Moreover, the Politburo, in its latest meeting, also stressed the rollout of new stimulus actions on the demand side of the housing market.

Even stronger hints of evergreen lending support came from the new central bank governor, Pan Gongsheng, who met with five major Chinese property developers, together with three manufactures, on August 3.  His message was that the PBOC would provide support for “reasonable financing demands” of the developers. This coincides with the heightened financial distress of Country Garden, China’s largest surviving developer after the loan defaults of Evergrande that started in late 2021. Yao Yu, the founder of a leading Chinese credit research firm, apparently said, “Certainly no one wants to see Country Garden fail.” The messaging of Governor Pan seems to be aimed at ring-fencing Country Garden, thereby avoiding contagion elsewhere in China’s battered property sector. Yet the lesson from countless financial crises, from Japan to the GFC, is that ring-fencing is highly problematic for markets and asset classes in distress.

Of course, as I wrote a month ago, there is a good deal more to China’s mounting Japanization risks than hints of evergreen lending.  After all, the CPI went negative in July, a Japanese-like whiff of deflation that can hardly be ignored. Like Japan of twenty years ago, today’s China is facing the tough macro headwinds of a declining working-age population and sagging total factor productivity.  Additionally, the lack of state-owned enterprise reform raises risks of a wider incidence of corporate zombies. All that underscores perhaps the most insidious parallel with Japan: The mounting debt intensity of the Chinese economy. China’s nonfinancial debt-to-GDP ratio hit a record 297% at the end of 2022, according to the latest BIS statistics; that is nearly 43 percentage points above the ratio in 2016, when leading officials in China—namely, the “authoritative person”—first expressed concerns about the possibility of a Japan problem with Chinese characteristics.  Flirting with evergreen lending hardly seems like a wise choice for China and its growing Japanization problems.

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