It’s not easy being a banking institution in China.  Often the lines are unclear between national and private interests, and political regulation has a large degree of influence over what personal loans can and cannot be made.  Most recently, stimulus regulations have required China bank loans to be made to local governments in order to pay for bridges, roads, and other infrastructure projects.  To some extent these loans were backed by an implied guarantee from the national government.  After all, it was the national government who mandated that the loans be made in the first place.

But this weekend an article appeared in the People’s Daily warning that China bank loans made to local governments could face risk of default based on the municipality level rather than holding the full faith and credit of the China government.  According to the Wall Street Journal article, the weekend piece “calls into question the safety of billions of dollars of debt backed by local governments country-wide.”

The possibility of these China bank loans defaulting appears to have been overlooked by lenders for the most part.  Since railroads and highways are largely being sponsored by the central government.  But it now appears that as the projects are completed, the liability will be maintained by local authorities who inherently represent a much greater risk.

China as a whole continues to be a bright spot in the bleak global economic picture.  While growth levels have certainly contracted, China is still increasing its GDP quarter after quarter while most of the other superpowers are shrinking.  Much of the growth in the past two years has been a direct result of the China stimulus measures which have largely been funded by these China bank loans.  If banks are forced to re-price the risk on these loans it will likely mean higher interest rates and potentially less capital available for the projects which are currently helping to prop the country up.

The People’s Daily has historically been a mouthpiece for the central government, reflecting the views of China leadership and the future path policy will likely take.  While some say the paper has lost some of its relevance as China emerges as a free economy, the words are still sobering and worth considering.  From an investment standpoint, there is danger not just in the China financial sector, but also in infrastructure companies with projects financed by these banks.

Currently we have a very positive outlook on infrastructure stocks.  Stimulus measures around the world continue to keep the backlog of projects robust.  And doing business with governments has historically meant that collecting payment for these projects is reliable (if not filled with red tape).  But new concerns with China bank loans coupled with rumors that some G-8 members believe spending has gone too far makes it necessary to take a close look at these investments.

One of the traits of a good investor is the ability to re-evaluate a position or theme when new information becomes available.  It is tempting to be stubborn and stick with a theme that we have worked hard to research and establish positions in.  But at ZachStocks we don’t want to be married to a particular sector if new information proves that there is more risk than we originally accounted for.  So for the time being we are still bullish on infrastructure stocks, and growth in China.  But new information on China bank loans will certainly be worth watching closely and may eventually lead to a change of opinion.

FD: The ZachStocks Growth Model holds positions in China and Infrastructure stocks.

Enjoy this article? Sign up for the ZachStocks Newsletter,
Your source for Sound Market Commentary, Growth Stock Analysis and Successful Investment Strategies

Need fast money? Instant Cash Advances Online from CashAdvancer.com can get you up to $1500 directly into your checking account in just 1 hour.