- China’s credit impulse declined by no less than 25% y-o-y
- In mid-2018 China will go through a significant slowdown
- China is reorienting credit towards innovation and productivity
- China’s new mantra: do more with less
To do more with less you've got to think differently. Photo: testin/Shutterstock
By Christopher Dembik
New GDP data has been published allowing us to update our in-house Credit Impulse Index for China. This index tracks the flow of new credit issued by the private sector as a percentage of GDP.
It appears that China’s credit impulse declined by no less than 25% year-on-year in the second quarter of 2017, therefore reaching a new post-crisis low.
This index leads the real economy by 9 to 12 months, meaning that in mid-2018 China will go through a significant slowdown. It is, at least partially, the result of the Chinese strategy of stricter control over the banking system and reorientation of credit towards innovation and productivity at the expense of industrial overcapacity.
Gradually moving towards a tightening stance
The shift towards credit restriction has started since the second part of 2016. Since then, China’s monetary policy has been moving towards a tightening stance. The PBoC has especially relied on Medium-term Lending rates to manage liquidity more efficiently. As a consequence, since the beginning of 2017, MLF rates (graph below) have been raised twice, from 2.85% to 3.05% for 6-Month rate and from 3% to 3.20% for 1-Year rate.
The 7-day repo rate, which represents a pertinent liquidity indicator for China, has also moved higher since the end of 2016 to a monthly average of 3.15% in September 2017 versus 2.55% in September 2016.
Credit tightening is mostly aimed at: 1) pushing lower credit growth but especially mortgage loans and loans from rural banks; and 2) curbing further shadow banking and wealth management products. However, credit restriction is not a one-way direction. We expect some slight adjustments in the course of 2018 as a result of lower growth. The PBoC could adopt a more targeted approach, as it has recently suggested, by cutting by 50 basis points the RRR for banks that provide loans to SMEs, start-ups, farmers and the poorest. Such a cut would be another step in the direction of credit control to support government-favored sectors and promote more qualitative growth.
In addition, we expect the 7-day repo rate will play a greater role as a benchmark for monetary policy to the detriment of the RRR due to its numerous advantages, such as: stabilising the money market, providing an efficient source of money market funding or as an easy to use tool for central bank.
More credit needed for less growth
The wall of debt in China (graph below) remains, of course, a tremendous challenge but our mistake, as Westerners, is that we overfocus on the problem of debt (labelled mostly in local currency!) and barely pay attention to the fast-growing green and technological revolution.
Since the great financial crisis, China has understood that more credit is needed for less growth than before. Historically, the uncontrolled accumulation of credit has almost always led to financial collapse.
The only way to deal with a large stock of debt (reaching 256.9% of China’s GDP in Q1 2017) is to reach a high level of growth. To achieve this, the only rational policy is to innovate in order to increase productivity.
This is China’s new mantra: do more (in terms of growth) with less (credit) but more innovation.
— Edited by Clare MacCarthy