China set to ease?

Exclusively from Michael Pettis newsletter:

Credit growth in China has been tight in the past month or two.  This hasn’t yet shown up in the GDP growth numbers, but if low credit growth continues, it will almost certainly result in much slower GDP growth.  The main thing generating growth in China is investment, and investment is largely funded by extremely cheap bank loans.

Last week my assistant Chen Long sent me information about a recent PBoC release:]

The total social financing numbers were updated today.  TSF was lower by RMB 1.26 trillion year on year. It slowed down quite significantly in the third quarter mainly because of the sharp drop in bank acceptance notes. Off-balance sheet products barely increased in the third quarter.

TSF, it should be remembered, is a new measure of credit growth introduced by the PBoC in February.  Prior to the introduction of TSF most of us focused on new RMB loans made by commercial banks as the proxy for loan growth in China.  This made sense a decade ago, but no longer.  As recently as 2002 RMB loans comprised 92% of what the PBoC included in the TSF category, but by 2010 they had dropped to 56%.

The reason?  Chinese banks are extremely eager to expand loan portfolios, since their guaranteed margins are huge and most of the credit risk is explicitly or implicitly socialized.  Borrowers who have access to bank credit are also eager to borrow because the real lending rate is extremely low and may even be seriously negative (it depends on whether you accept the CPI as the best proxy for price changes).  The only losers when it comes to explosive loan growth, it turns out, are Chinese households, whose very low-yielding deposits fund all of this activity.

Under these conditions any attempts by the regulators to constrain credit growth would simply result in “innovations” by the banks and borrowers aimed at getting around these constraints.  And so the banks innovate.  Much of the growth in credit in the past decade has occurred not in the form of new RMB loans (although these did grow quickly) but rather in other forms that were not monitored and constrained to nearly the same extent.  The PBoC’s creation of the TSF measure was an attempt to give the regulators a more useful way in which to monitor and regulate credit growth.

But the problem has not really been resolved, since much loan growth now seems to occur outside the TSF categories.  In fact it is getting harder than ever to get a real handle on what is happening with credit growth in China as more and more transactions occur off balance sheet and in the informal markets.  M2 itself has become a pretty uncertain measure of money growth because along with disintermediated loans, we are also seeing disintermediated deposits, and these no longer show up in M2.

What’s more, when the informal markets contract in a way that poses systemic risks, the line between informal and formal financing tends to get blurred.  Here is an article from last week’s Caixing:

Banks have been ordered, against their will, to go easy on loan clients as Wenzhou’s government tries to control defaults.  Wenzhou bank executives recently complained that city government officials in this bustling commercial center were behaving like a drowning man clutching at straws.

“Sink or swim” is probably what the bankers would like to tell local officials.  But as the city struggles with a wave of defaults and factory shutdowns blamed on heavily indebted companies, and in the face of government penalty threats, Wenzhou’s bankers have quietly complied with city hall orders to grant loan extensions and show clients flexibility when loans come due.

If too many SMEs, many of whom borrow at high rates from the informal sector, get into trouble, in other words, banks are asked to step in, so transferring to formal banks risk once held by informal banks.

So is credit expanding in China?  I think in the past month credit growth has slowed significantly, and in fact this might well be related to the surprisingly low increase in central bank reserves in the third quarter.  The current account surplus during the period was $63.8 billion.  Reserves, however, only rose $4.2 billion to $3.2017 trillion.

This is a low number.  I haven’t figured out what the impact of changes in currency values will have had, but it seems pretty clear that one way or another we have seen net outflows of speculative capital recently, and this is of course consistent with the weakness in the Hong-Kong-traded RMB, which has dropped over 2% relative to the onshore RMB.

We need to wait a few more months before coming to any firm conclusion, but at least in the short term strains in the financial system are clearly increasing.  If there is hot money outflow funded by drawing down bank deposits, this will put even more pressure on the smaller banks, who are having trouble funding themselves as it is.

One interesting additional piece of information on strains in the banking system was provided last week.  Since 2006 the PBoC regularly auctions MoF deposits (usually on a monthly basis) to the highest bidder among commercial banks.  These auctioned deposits, unlike ordinary deposits, are not constrained by deposit rates set by the PBoC.  In some ways this is one of the better measures of what the deposit rate would be if it were unregulated, although even this number is seriously distorted by the official deposit rate.

Last week, six-month deposits were auctioned at 6.83%, which is higher than the minimum lending rate and the highest auction rate ever achieved since these auctions began in 2006. Banks, it seems, are liquidity-constrained, at least the smaller banks.

I wish I knew better what was going on in the credit markets and whether we can expect the recent tightness to continue, but I think it is still too early to say.  If credit growth continues as low as it seems to have been in the past month, I expect GDP growth will slow sharply, but my suspicion is that we are going to see relaxation quite soon.

Recent comments by Premier Wen, about the need for government policy to be “more targeted, flexible and forward-looking,” as reported in People’s Daily, suggest that there isn’t likely to be much appetite for a much more rapid slowing of economic growth.  I hope I am wrong, because the sooner we start reducing credit growth the more room Beijing will have to maneuver through what will anyway be a difficult rebalancing.  The more bad debt on Beijing’s balance sheet, the more sudden and difficult the adjustment will be.

But given that next year is politically important, my guess is that we won’t see too much more tightening.  One of the reasons why we won’t was probably suggested by events last week in Shanghai.  According to an article in the South China Morning Post:

Hundreds of angry home buyers launched a series of protests in China’s commercial hub of Shanghai this week, as owners decried falling prices for their properties, state media said Thursday.  Hit by weak demand and lack of funding, developers have slashed prices for some new projects in the city by more than 20 per cent, the China Business News said, causing an outcry among those who bought at higher levels.

Analysts said the sometimes violent protests signalled that government measures designed to cool the red-hot property market were working and they warned developers in other parts of the country were starting to cut prices.  In the latest incident, some 200 home owners on Wednesday besieged the sales office for a project of leading developer Greenland Group, demanding refunds.  “We require a refund because the loss we are suffering now is too great for us to afford,” the Shanghai Daily quoted a protestor as saying.

,,,In a another incident, 30 home owners stormed the sales office of a project of Hong Kong-listed China Overseas Land & Investment on Wednesday, the Global Times said, repeating a similar protest from over the weekend.

In at least one case, protests have turned violent. Home owners smashed a glass door over the weekend at a sales office of Hong Kong-listed Longfor Properties for another project in a Shanghai suburb.  A property analyst said developers had started to cut prices in other parts of China, which could potentially lead to similar protests elsewhere.

Chinese apartment buyers have been drilled so continuously with the mantra that real estate prices can never decline that declining prices have come as a real shock.  In fact for many years the only reason for buying an apartment was that next year it would be 20-30% more expensive.  This belief has even affected the marriage market.  It is widely believed here in China that young men without apartments are unlikely to find young women to marry, and so worried parents of boys have been buying apartments for their sons, years before the boy would even consider getting married, in order to reduce the eventual cost of the marriage.

So declining prices in the past year have created a shock for many.  I wonder how many months of declining prices we will see before Beijing becomes worried about the social impact.  Not that there is much they can do – we clearly need to see apartment prices decline in the big cities, but getting them to decline gently is never easy. Relaxing credit and directing banks to make it easier (and cheaper) for real estate developers to fund unsold inventory is certainly one way, but this is likely to come with the same old unintended consequences – more real estate investment.

As an aside, my friend Jim Walker at Hong-Kong-based research shop Asianomics annoyingly asked in his newsletter yesterday why – if apartment purchases have been driven largely by families looking for primary homes (as we have been told many times) – would they be so violent over declining apartment prices?  Perhaps they might be annoyed at not having waited a little longer before buying, but should declining apartment prices really make them worse off enough to protest in the streets, and in fact shouldn’t they actually make it easier for them to trade up into a better apartment?

Could it be, Walker wonders, that most buyers are actually speculators, and have purchased on borrowed money?That should cause them to make more of a fuss over declining prices than it would for families who actually plan to live in those apartments.


  1. Sounds worrying but fortunately we know it will pass as China is different. Final stage of capitalism before pure communism? 🙂