Chinese banks face potential defaults

Currencies Direct July 27th 2010 - 2 minute read

One in fifth of the 7.66 trillion yuan (1.1 trillion dollars) that Chinese banks lent to local governments is “at serious risk of default”, is the latest potential default risk problem to halt the global recovery. Chinese banks lent vast sums of capital to local Chinese governments for construction projects after Beijing called for nationwide efforts to stimulate the economy. However, only one quarter of projects financed by the loans have the ability to meet repayments, according to the Century Weekly. The banking regulators, along with the banks that have the biggest exposure, will carry out detailed discussions with local governments starting in September about how to recoup the loans, the report said. China has powered out of the global crisis on the back of a stimulus package worth four trillion yuan and the state-backed bank lending, which saw new loans nearly double from the previous year to 9.6 trillion yuan in 2009. This latest potential default raised concerns in Beijing over a possible new crop of bad loans that could threaten the world’s third-largest economy. The question is will the fresh concerns undermine the AUD in the short and medium term?

Following much hype and media coverage, the European bank stress tests were released on July 23, after European markets had closed, and met a subdued U.S. market reaction which was rather more interested in the immediate and clear positive stock price effects of a takeover offer for Genzyme. Though we anticipate some positive market movement due to an improved level of disclosure than expected, reducing concerns of the “End of the world” scenario and the approach of the holiday period, the test ultimately fails to ease our concerns about the toughness of European banks and, therefore, the scale of the potential liabilities that stressed sovereigns will need to backstop in the midst of a low-growth environment. In addition, funding markets remain uncomfortable, as demonstrated by the continued ascent of Euribor rates.

The euro briefly traded above 1.30 against the dollar overnight. A combination of growing confidence in Europe’s economy buoyed by Deutsche Bank’s impressive results, a bigger than forecast increase in US new home sales in June and a boost in FedEx corporate earnings prospects made riskier assets more attractive. US new home sales were up 23.6% in June, well up on expectations and a sharp rebound against a drop in May of 36.7%. This still leaves sales at historic low levels and concerns remain for the outlook of the US economy. Housing data weakness has weighed on investor sentiment and the outlook for housing will depend on jobs as a strengthening labour market would provide support to sales in the latter half of this year.

The pound hit a five month high against the dollar after an improved tone boosted by the stress tests combined with last Fridays better than expected GDP figures gives a more upbeat outlook for the UK economy and currently trading at GBPUSD1.5452 and GBPEUR1.1893. Today sees the release of the CBI distributive trades survey for July.

This afternoon the dollar is in focus with the release of the Shiller US Price Index for May as well as Conference Board’s Index of consumer confidence for July.

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