China's Growth Story Too Dependent On Easy Credit?

Just how dependent is the China growth over the last 6 months on the easy credit conditions? This blog has been harping on the liquidity trap that is almost inevitable. The flip side is that the markets in China and HK will continue to benefit as Beijing would continue to "allow and encourage" more state firms to list in Shanghai and/or do a H-share listing - both very effective ways to drain some of the liquidity from the system, or at least keep it within a sphere where it could be 'controlled' somewhat.

Bank lending surged in H1 2009 to RMB7.37 trillion (US$1.08 trillion), more than three times higher than H1 2008. The figure, totaling 25% of China's annual GDP in 2008, is 47% higher than the government's RMB5 trillion target for 2009. There is significant monthly variation, however. Available data suggests that lending slowed in July 2009 even more than in April and May 2009, but June loans surged to RMB1.53 trillion (US$224 billion), a return to Q1 levels. New loans could surpass the revised RMB10 trillion benchmark for 2009. The scale of loan extension has sparked sustainability concerns, raised the risk of non-performing loans (NPLs) and helped to fuel asset-price inflation (property and equities). However, concerns that the government might rein in loans contributed to a weakening of equity markets in early August.

Will Lending Growth Continue?

• Banks lent RMB1.53 trillion (US$224 billion) in June, more than double the RMB664.5 billion extended in May, sparking concerns that tightening may follow. M2 rose 28.5% in June, and outstanding loans were up 34.4% y/y in June (both record highs). The central bank may have already started to tighten, selling more bonds to soak up some of the liquidity.
• The reported lending figures from China's largest banks suggest that July's new lending should total around RMB400 billion (US$58.6 billion). Many of the commercial bills from earlier in the year will be refinanced in July through September, reducing new lending. Still, credit availability will likely remain relatively loose.
• The big four banks reportedly cut lending to RMB168 billion (US$24.6 billion) in July from RMB497 billion (US$72.7 billion) in June, though smaller banks have increased their share of lending in recent months from about half to two-thirds. As a result, lending may not have slowed as much as some estimate.
• If state-owned banks contributed one third of July new bank lending, like they did in Q2, then the July figure should come in around RMB500 billion (US$73.2 billion). Though if the trend of smaller commercial banks contributing a greater share continues, the actual figure could be higher.
• The narrowing spread between M1 (18.7% y/y in May, up from 17.5% in April) and M2 (25.7% y/y in May, down from 26% in April) suggests that economic growth is gaining momentum as corporations are increasingly confident and willing to embark on future investments.
• Loan growth shifted toward medium- and long-term loans in Q2. Commercial bills accounted for 21% in April, down from 32% in Q1, while other short-term loans declined by nearly RMB80 billion. Deposits again outpaced loans, reducing the loan-deposit ratio, which should marginally ease fears of bad debts, as firms are storing liquidity.
• Even if loan growth slows, the net increase in loans might be around RMB8-8.5 trillion, 26-28% above 2008 for loans outstanding.

Factors Behind Lending Expansion


• The People's Bank of China (PBoC) is unlikely to tighten monetary policy because the central bank is not accountable for regulating bank risk. Bank lending is playing an important role in the fiscal stimulus, and the central bank may plan to pump in money to fill holes in banks’ balance sheets from bad loans.
  
• The Banking Regulatory Committee is raising minimum capital adequacy requirements from 8% in 2008 to 12% by 2010, but the PBoC controls the reserve requirements, blunting the regulators’ ability to control loan growth.
• The China Banking Regulatory Commission may rule that subordinated debt held by another bank will no longer qualify as supplementary capital. Estimates suggest that as much as 51% of subordinated debt issued by banks (RMB210.0 billion in H1 2009, three times last year's total level) is held by other banks, which could lead banks to curtail new lending. That would be an easier path to better capital-adequacy ratios than finding buyers for the debt outside of the financial sector.
• The China Banking Regulatory Commission suggested that a concentration of credit in some industries and businesses may pose a threat to the financial system. Banks should rely more on syndication to share the risks from new lending, the secretary of the commission said.
• Loan growth is driven by monetary policy that encourages banks to expand loan portfolios. Banks make up for lower loan margins with expanded loan volumes and an assumption that stimulus-related credit losses will be covered by the central and/or local government. The increase in corporate loan portfolios and credit expansion may threaten the medium-term outlook for Chinese banks.
  
• Michael Pettis, Peking University: "Tighter monetary policy may be necessary to contain future inflationary pressures, but the unclear economic outlook and political priority of growth make this unlikely."
  
• Wu Xiaoling, PBoC Deputy Governor: The government's moral persuasion is declining. Banks should diversify, but not lend excessively in search of sustainable profits.
• Loan curbs postponed investment in H2 2006, while loans and investment reaccelerated in Q1 2007.
  

Risks from Lending Growth

• The efficiency of new loans is in doubt, as the economy does not have the capacity to turn these new loans into real activity. Potential tightening policies would further challenge the financing of small and medium sized enterprises.
• NPLs may not reach 1990s levels, as most of the current round of lending has gone to local-government-backed projects rather than unprofitable state-owned enterprises. Also, because Chinese banks are more dependent on deposits than wholesale markets for funding and China's capital account remains closed, there is little risk of a financial crisis.
• As much as 20% of the bank loans in the first five months of 2009 (US$170 billion) was invested in the stock market, while another 30% may have been used for discounted bill financing.
• China's National Audit Office found that six Chinese banks in 2008 had extended more than US$4.39 billion worth of irregular loans, an indication of inadequate management at some of the banks' local branches. The issues included improper land purchases, fraudulent mortgages and loans to non-qualifying property developers and non-approved mortgages.

p/s photos: Meisa Kuroki