Credit is flowing rapidly in China as Beijing gets growth back on track, creating positive momentum…
Media interviews of Wen Jiabao reportedly conducted in Thailand prior to the cancellation of the ASEAN summit this weekend outlined the bullish case for the Chinese economy, with the premier confidently cataloguing signs that expanding credit and stimulus projects have started to fuel a rebound in industrial demand. At +38% YTD, Chinese stocks shot to new 2009 highs on the “news”.
Increased credit liquidity flowing from the People’s Bank of China (PBC) has been a critical foundation for Beijing’s recovery plan. All signs indicate that this loosening has had a rapid and massive impact with PBC new loans increasing by 1.89 trillion Yuan in March and Friday’s M2 release showing an increase of 25.43% Y/Y for the same period.
PBC leaders now find themselves balancing the political pressures to help fuel a rebound in growth with a practical need to avoid any further increase in non-performing loans. This tightrope is underscored in the awkward language of the PBC’s press release this week in which they pledged to continue to “implement moderately loose monetary policy and maintain the continuity and stability of policy”.
Officially, non performing loans accounted of under 2.5% of the total on the books of the major commercial banks in Q4 of last year, but as we noted in our note on April 3rd (“Ticking Time Bomb?”) the rising use of “special mention” classification for troubled loans and the restructuring of the Asset Management Corporations have muddied the picture so much that it is impossible to ascertain what the true percentage of loans that are non performing is.
The critical factor in preventing a bubble as credit expands and works through the system will be regulation –which has been an Achilles heel for the Chinese financial system. Up to now, reform of the financial system has been carried out cautiously and gradually as the desperate need for better controls for smaller banks has been balanced against political measures designed to protect more fragile institutions and to prevent competition. As such, although the banking system has evolved and made progress there are substantial bank vulnerabilities that remain. Even after the reforms instituted after bad loans reached nearly 20% of those on the books at commercial banks in 2004, the Chinese financial system still lacks the fundamental ability to efficiently allocate credit through the economy, making this sudden flow of credit a source of great risk.
In the near term we are confident that the stimulus provided to the Chinese economy by this massive liquidity event will have the desired effect and drive rebounding internal demand. On the horizon however, we will be carefully watching developments in the opaque banking sector there for any signs of trouble.