Markets Insight
June 24, 2013 8:12 am
Markets Insight: China’s Ponzi credit boom faces crunch
PBoC’s resolute position is both good and bad news
Skittishness in global finance about the Federal Reserve’s intention to start “tapering” its asset purchases has been joined by rising angst about a credit crunch in China.
It is too early to say, but with the credit intensity of China’s slowing economic growth surging back this year to levels last seen in the 2009 credit boom, a severe credit squeeze could precipitate a big drop in investment, accentuate the downturn in growth and lead to financial and banking sector instability.
This would sour sentiment in global equity and commodity markets, strengthen the US dollar as well as accentuate capital outflows from and slower growth in emerging markets.
Interbank borrowing costs have been rising since the start of June, and surged late last week, finishing lower but at near-record high levels. An abrupt fall in foreign exchange inflows, possibly even some capital flight, and the seasonal tax payments were partly to blame.
The key, though, was the People’s Bank of China, which drained liquidity and refrained from repurchase and other operations in the face of shortages. The PBoC has signalled to Banks, in effect, that it will not accommodate further rapid credit growth.
The PBoC, together with other agencies including the China Banking Regulatory Commission, are trying to get to grips with hitherto weakly implemented regulation and unstable funding risks in China’s rapidly expanding shadow banking sector. Borrowers, especially local governments and state enterprises, and investors have flocked to shadow financing to bypass tighter regulations in the formal banking sector.
The interbank market, for example, is used by some banks and intermediaries to fund lending or offload loans from balance sheets. Shadow lending has increased by about a third since 2005 to stand at about Rmb28tn (50 per cent of GDP), and has been the dynamic component in the acceleration of “total social financing”, which comprises conventional bank loans and other lending, for example via trust companies, inter-company loans, commercial bills and corporate bonds. In the first five months of 2013, TSF expanded by an annualised 25 per cent compared with the already high level of 2012.
The PBoC’s resolute position so far is both good and bad news. The consequences of vigorous credit creation, especially when growth is slowing down for structural reasons, were never going to be a picnic. But it makes sense to tackle the problem sooner, rather than later, so as to contain and smooth the costs to investment, economic growth and bank balance sheets. The good news is that if the authorities succeed in lowering credit expansion, they will reduce the risk of a more serious credit crunch down the line, and lend credence to the economic reforms expected to be announced in October.
The PBoC’s policy stance echoes the more frugal political position taken by President Xi over party discipline and behaviour, and Premier Li’s recent statement that there is little the government can or should do to mitigate the economic slowdown, and that China’s economy must embrace “market mechanisms”. If it perseveres, easier policy will have to await clear evidence that TSF and above-target monetary growth are slowing down.
Meanwhile, the PBoC has tools to deal with excessive tightening in money markets. It can allow maturing bill transactions to provide gradual relief, inject liquidity to banks individually or via the open market, and, if need be, lower reserve requirements.
On the other hand, taming a credit boom is always risky, especially as, in China’s case, much of it lurks off balance-sheet, often in Ponzi-type layers of transactions, and subject to uncertain liquidity conditions. The combination of regulatory tightening and restricted liquidity in these markets raises the risk of miscalculation or an accident that might trigger the instability the authorities want to avoid. If economic growth then faltered, strong policy intent would succumb to weak implementation, and looser policy, regardless. Much-needed financial reforms, such as interest rate liberalisation, to help economic rebalancing along would stall.
Either way, the world will watch China’s credit conditions and liquidity management closely, especially with persistent downgrades to estimates of economic growth. The ramifications for countries locked into China’s supply chains have already been recognised. If these concerns were to be amplified by a more serious credit crunch, global financial markets would recoil, sending the US dollar higher.
Two previous US dollar bull markets acted as catalysts to bring down Latin America in the 1980s and Asia in the late 1990s. Another one would also have ubiquitous effects, especially on emerging markets, which have been the principal beneficiaries of risk capital.
George Magnus is an independent economic consultant, and adviser to UBS
It is too early to say, but with the credit intensity of China’s slowing economic growth surging back this year to levels last seen in the 2009 credit boom, a severe credit squeeze could precipitate a big drop in investment, accentuate the downturn in growth and lead to financial and banking sector instability.
This would sour sentiment in global equity and commodity markets, strengthen the US dollar as well as accentuate capital outflows from and slower growth in emerging markets.
Interbank borrowing costs have been rising since the start of June, and surged late last week, finishing lower but at near-record high levels. An abrupt fall in foreign exchange inflows, possibly even some capital flight, and the seasonal tax payments were partly to blame.
The key, though, was the People’s Bank of China, which drained liquidity and refrained from repurchase and other operations in the face of shortages. The PBoC has signalled to Banks, in effect, that it will not accommodate further rapid credit growth.
The PBoC, together with other agencies including the China Banking Regulatory Commission, are trying to get to grips with hitherto weakly implemented regulation and unstable funding risks in China’s rapidly expanding shadow banking sector. Borrowers, especially local governments and state enterprises, and investors have flocked to shadow financing to bypass tighter regulations in the formal banking sector.
The interbank market, for example, is used by some banks and intermediaries to fund lending or offload loans from balance sheets. Shadow lending has increased by about a third since 2005 to stand at about Rmb28tn (50 per cent of GDP), and has been the dynamic component in the acceleration of “total social financing”, which comprises conventional bank loans and other lending, for example via trust companies, inter-company loans, commercial bills and corporate bonds. In the first five months of 2013, TSF expanded by an annualised 25 per cent compared with the already high level of 2012.
The PBoC’s resolute position so far is both good and bad news. The consequences of vigorous credit creation, especially when growth is slowing down for structural reasons, were never going to be a picnic. But it makes sense to tackle the problem sooner, rather than later, so as to contain and smooth the costs to investment, economic growth and bank balance sheets. The good news is that if the authorities succeed in lowering credit expansion, they will reduce the risk of a more serious credit crunch down the line, and lend credence to the economic reforms expected to be announced in October.
The PBoC’s policy stance echoes the more frugal political position taken by President Xi over party discipline and behaviour, and Premier Li’s recent statement that there is little the government can or should do to mitigate the economic slowdown, and that China’s economy must embrace “market mechanisms”. If it perseveres, easier policy will have to await clear evidence that TSF and above-target monetary growth are slowing down.
Meanwhile, the PBoC has tools to deal with excessive tightening in money markets. It can allow maturing bill transactions to provide gradual relief, inject liquidity to banks individually or via the open market, and, if need be, lower reserve requirements.
On the other hand, taming a credit boom is always risky, especially as, in China’s case, much of it lurks off balance-sheet, often in Ponzi-type layers of transactions, and subject to uncertain liquidity conditions. The combination of regulatory tightening and restricted liquidity in these markets raises the risk of miscalculation or an accident that might trigger the instability the authorities want to avoid. If economic growth then faltered, strong policy intent would succumb to weak implementation, and looser policy, regardless. Much-needed financial reforms, such as interest rate liberalisation, to help economic rebalancing along would stall.
Either way, the world will watch China’s credit conditions and liquidity management closely, especially with persistent downgrades to estimates of economic growth. The ramifications for countries locked into China’s supply chains have already been recognised. If these concerns were to be amplified by a more serious credit crunch, global financial markets would recoil, sending the US dollar higher.
Two previous US dollar bull markets acted as catalysts to bring down Latin America in the 1980s and Asia in the late 1990s. Another one would also have ubiquitous effects, especially on emerging markets, which have been the principal beneficiaries of risk capital.
George Magnus is an independent economic consultant, and adviser to UBS
Copyright The Financial Times Limited 2013.
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