The Chinese slowdown is coming

Charlene Chu at Autonomous Research is making waves at the FT today:

Corporate investigator Violet Ho never put a lot of faith in the bad loan numbers reported by China’s banks: crisscrossing provinces from Shandong to Xinjiang, she’s seen too much – from the shell game of moving assets between affiliated companies to disguise the true state of their finances to cover-ups by bankers loath to admit that loans they made won’t be recovered. The amount of bad debt piling up in China is at the center of a debate about whether the country will continue as a locomotive of global growth or sink into decades of stagnation like Japan after its credit bubble burst. Bank of China Ltd. reported on Thursday its biggest quarterly bad-loan provisions since going public in 2006.

Charlene Chu, who made her name at Fitch Ratings making bearish assessments of the risks from China’s credit explosion since 2008, is among those crunching the numbers. While corporate investigator Ho relies on her observations from hitting the road, Chu and her colleagues at Autonomous Research in Hong Kong take a top-down approach. They estimate how much money is being wasted after the nation began getting smaller and smaller economic returns on its credit from 2008. Their assessment is informed by data from economies such as Japan that have gone though similar debt explosions.

While traditional bank loans are not Chu’s prime focus — she looks at the wider picture, including shadow banking — she says her work suggests that nonperforming loans may be at 20 percent to 21 percent, or even higher.

God only know the truth of it. What we can say is that you can’t have the kind of growth China has enjoyed for a decade and embed enormous bad loans.

I’m more interested today in some new charts from Autonomous on the pending Chinese slowdown:

WHAT WE EXPECT IN 2H17: Given the strength of last year’s credit impulse, which peaked at a revised +13.8% of GDP in 4Q16, economic activity should continue to hold up in 2H17, with nominal GDP growth likely to close the year at 10-10.5%. This will be down from a peak of 10.5-11% in 3Q17, so will represent a deceleration and be trending weaker, but nevertheless remains solid. Growth in 2018 will be under pressure, as a negative credit impulse by year-end begins to pass through to economic activity.

Market-driven interest rates have been falling in recent weeks, but we think a full retracement is unlikely due to a genuine need for tightening given elevated property prices and non-food CPI and a desire to keep the squeeze on bad behaviour at financial institutions.

Looking further ahead: Whether GDP growth flattens for several quarters after peaking – as it did after the 2009 and 2012 credit impulse cycles (see Chart 3 at right) – or starts to decelerate straight away is a question. We lean toward the latter given how rapidly and deeply the credit impulse will be turning negative.

Key wildcards: (1) Inflationary pressure appears to be easing, but with property related credit as strong as it has been and economic activity still very robust, we see a risk that property prices and non-food CPI stay elevated for longer, placing a constraint on the authorities’ ability lower interest rates. (2) We expect the slowdown in growth to start off as a cyclical one, but the authorities’ focus on addressing financial sector excesses and corporate over-leverage could rapidly morph into something deeper, particularly if the authorities were to abandon their more cautious Chinese medicine approach to dealing with the country’s debt problems. (3) Capital outflows and the exchange rate have stabilized, but we believe long-term pressure remains on both. Any reappearance could reignite concerns about a large CNY move unleashing a wave of global deflation.

Neatly dovetails the MB view…

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