Why has China turned on the credit tap?


Find below an excerpt from a recent Alliance Bernstein note making some arguments for why China has, once again, hit the credit afterburners:

Respectable Achievement So Far

Until recently, we thought that the PBOC had built a solid credential on financial reform and that it was taking a hard line on containing the leverage risk in the economy. Governor Zhou Xiaochuan repeatedly talked tough on the need to maintain a prudent monetary policy, and the PBOC’s policy focus shifted from its traditional benchmark, the one-year lending rate and loan quotas, toward the more day-to-day interbank rates, banking system liquidity and open-market operations.

Remarkably, the changes occurred in just the past year or so and have paved the way for a proper interest rate–based monetary policy structure. Moreover, growth in shadow credits is better controlled—especially the troublesome trust loans—and traditional bank loans have not been ramped up to fill the gap either. Growth in the total stock of credit has slowed and is more in tune with that of nominal gross domestic product.

Also, there were a few minor credit defaults in the first quarter, which stirred a healthy mix of hopes and fears about a serious deleveraging, disposal of nonperforming loans and the development of a market-based process to price risks. And last but not least, there was a decisive move to increase the flexibility of the renminbi’s exchange rate against the US dollar (CNY/USD), as well as a continued push for the internationalization of the currency via the RQFII (Renminbi Qualified Foreign Institutional Investors) scheme.  So why put a brake on the reform momentum?

Political Pressure Heightens

The reason for the recent change in thePBOC’s policy is subject to many interpretations. Our take is that President Xi Jinping’s crackdown on corruption may have been too aggressive in terms of slowing the local governments’ investment and consumption (largely in luxury consumer goods and restaurant banquets).

A downturn in the housing market should be another important reason.

As the fear of a more severe economic downturn builds—rightly or wrongly, since we see no major worsening in China’s tight labor market—the easy path for the central government to respond to slower growth without departing from Xi’s high-profile reform program is to ask the central bank to hand out liquidity.

The PBOC has, so far, taken on this task quite discreetly. The easing—in reserve requirements, relending and the loan-todeposit ratio—has been selective and piecemeal in nature, and mostly targets just the rural sector, infrastructure and small firms—the policy target for the current economic development plan anyway. Although it is difficult to accurately gauge the overall scale of the selective easing measures, we suspect that they amounted to less than RMB1 trillion, which accounts for a fraction of China’saggregate credit outstanding (including shadow credits), estimated at some RMB120 trillion.

However, the problem is not the size of the easing, but the nature of it. The policy is at the discretion of the PBOC, lacks transparencyand essentially means a return to quantitative control.

The central bank stopped using its relending facility years ago, but it is now injecting liquidity into specific state banks, with funds that are earmarked for certain end-users. This, in our view, more resembles fiscal stimulus than monetary easing. The proper way for this kind of
policy-driven lending is the injection of capital from the finance ministry to the state-owned policy banks. This way, policymakers can avoid tarnishing the good intentions of transforming the banking system into a more transparent and market-driven one.

Running Counter to Great Plans?

Even amid these recent moves, we continue to hear talk of the PBOC’s intentions to make the short-term
interbank rate or the repo rate as its official policy tool, like the fed funds rate in the US, and also to establish a rate corridor to guide market liquidity.

At the risk of sounding too technical here, the discussion has, for instance, been that the ceiling could be determined by either the SLO (Short-Term Liquidity Operation, which provides liquidity for open market operation) or SLF (Standing Lending Facility, which provides liquidity to selective banks during periods of shortage). The floor could be the interest rate on excess reserves, the funds that commercial banks keep overnight in their deposit accounts with the central bank. The PBOC is also keen to develop a medium-term policy rate to guide longer-term interest-rate expectations, and one likely candidate is the recently introduced PSL (Pledged Supplementary Lending, with which the central bank can ”pledge” loans to targeted sectors or provinces as necessary).

All of these sound great, and we certainly applaud the PBOC for speedily developing these facilities to pave the way for a more sophisticated monetary framework. However, a crucial factor in helping these facilities mature, and ensuring the future systems will work effectively, is the openness of their access and the transparencyof the operation. The recent moves to allow more case-by-case liquidity easing,both in size and users, represent a departure from that open-market policy trajectory. We hope this is only temporary, minor political bargaining.

Sounds right to me. Not the end of reform, certainly. But this adjustment could take a long, long time.

David Llewellyn-Smith
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  1. Because they have no choice. They cannot escape the hard landing – net manufacturing (exports minus imports) now makes up only a small part of their economy (some estimates have it around 6-8% of GDP). The Chinese economy does not operate outside the sphere of economic gravity, and it is increasingly obvious that the government has to keep pumping the money or a crash will ensue, and maybe a serious depression with all that implies – even a change in leadership? Chinese QE anyone?

  2. Private credit growth collapsing. Naturally, the gov’t must step in to spend so that unemployment does not spike a lot higher. Asset prices will still decline.

  3. I still don’t see the point of the title ‘turning on the credit tap’. The article talks mainly of the structural reforms the PBoC is making in how it exercises it’s monetary tools. Targeted lending through rural banks is hardly gushing the taps.

    • I don’t know of any instances of targeted lending in China. Thats the whole point… you reduce the reserve ratio, force the banks to lend more, rural or otherwise (they only mention rural because that is where the biggest drop has occurred to date – in third-tier cities, hence they want to contain any possible contagion). And when the reserve ratio diminishes its effect – I suspect thats when you will seed them start whole-scale printing, induce asset inflation.

      I agree about asset prices. They are wholly outside the Governments realm of control !

      • The govt makes lending targets and quotas all the time to banks. It has cut quotas to overcapacity industries like steel solar panels coal etc while increasing quotas to consumption / environment industries. You won’t see it publicised but can read it in banks published accounts. And sorry you are wrong the govt lowered reserve ratio only for rural and other selected banks not all.

      • That is factually incorrect. Yes the government sets targets, but it is almost entirely up to provinces to establish benchmarks and implement programmes – for instance, the Chinese solar bubble which burst 12 months ago could have been started by central government via espionage and acquiring Germany panel technology initially – but its growth and subsequent collapse in China had nothing to do with central government directives. That was purely organic.

        Likewise, a recent government audit into regional province finances, despite a large publicity programme beforehand, the results have never never released, some internal Chinese commentators (uncorroborated – not sure where they got their information from) suggested that the total debt found was greater than double the most optimistic central government estimates. There is a reason why China has a proverb “shan gao, huangdi yuan”, meaning the mountains are high and the emperor is far away.

        If you actually read what I wrote – I did not say the government lowered reserve ratio only for rural and other selected banks. I mentioned they lowered the reserve ratio period – and that they will continue to do so until it is ineffective.

        You misunderstand how the provincial construction bubble actually started – it had precious little to do with the central Communist party. It is purely a provincial initiative. I don’t dispute central government influence – and some monetary stimulus. But they are paltry sums when you compare the vast amounts of debt (<US$25-28tn) – the vast majority held by provinces and state owned firms. Stimulus sums (ranging from hundreds of millions to several billion USD – depending upon project) by comparison are nothing but sand in the wind…