No sooner had China last month reported its worst quarterly
growth in nearly two decades, than markets rallied.
The rebounding optimism was partly the result of other data
also published by the government which suggests that the
deepest part of the downturn may have passed, amid a wave of
government spending. But it also reflects a belief that growth
having hit 6.1% in the first quarter has finally
Urban fixed-asset investment surged by almost a third in March;
industrial-output growth accelerated; and retail sales were 16%
higher in real terms than a year ago. A sharp decline in
exports 17% in the year to March has been offset
by lower imports to raise the trade surplus to $50 billion in
the first two months from $37 billion a year earlier. Also,
encouraged by rumours that further economic stimulus measures
will soon be forthcoming from Beijing, Shanghai stocks leapt to
an eight-month high.
Following the release of first quarter data, Chinese premier
Wen Jiabao noted that the countrys four trillion yuan
($585 billion) stimulus policies had delivered better results
than expected. Although he added it would be best to stay
cautious in judging the economic situation, many took the
statement to mean that the recession has run its course.
Todays slump is easily the countrys worst since the
downturn of 198990, when the economy grew at 5%. It marks
an immense plunge from past growth that hit a record 13% in
But growth estimates are now being widely revised upwards.
Chinas central bank says the country is on track to hit
the governments target of about 8% this year. Private
forecasters are also changing their tune: Goldman Sachs reckons
Chinas economy will expand 8.3% in 2009 from an earlier
estimate of 6%; CLSA Asia-Pacific Markets also increased its
estimate for growth this year to 7% from 5.5% earlier; and
other firms including Merrill Lynch, Barclays Capital
and RBS have also raised their expectations.
Its hardly a surprise that the faintest sign of an early
recovery is being taken as hard evidence of that supposed fact:
many prayers rest on the recovery of the worlds
third-largest economy. The return of Chinese demand would
support export-dependent Asian nations, whose economies are
contracting sharply. Meanwhile raw materials producers the
world over are looking to Chinas stimulus programme to
drive commodities demand.
Not so fast
The economy is stabilizing the stimulus programme
is starting to work, and other economic policies are showing
effects, says Fred Hu, managing director at Goldman
But he cautions against reading too much into the recent data.
This doesnt mean that the recovery is broad based
or sustainable and that this will be a fast V-shaped
upturn. It will take at least another quarter for a
possible recovery to establish itself, but its extent and
durability will depend on the global economy as a whole, he
Larry Brainard, chief economist at Trusted Sources, an emerging
markets research firm, says an uptick in growth on the back of
the recent stimulus is likely to give way to a slump before any
sustained recovery kicks in. Were looking more at a
W-shaped recovery, not a V says
Brainard. To have sustained growth, China needs to have
domestic demand. Thats whats necessary to rebalance
Last September, in response to global financial shockwaves, the
Peoples Bank of China began to cut interest rates; and in
early November the government launched its fiscal stimulus
package. The combined effect of the measures has led to an
unprecedented flood of bank lending.
The explosion in Chinas bank lending this year
compared with the contraction in credit in many western
countries has been crucial to shoring up consumer and
business confidence, and to keeping the economy expanding.
Between January and March banks lent 4.6 trillion yuan, an
amount thats already pushing Beijings target of 5
trillion yuan ($731 billion) of new loans for the whole of
The March total of new loans alone rocketed to almost 1.8
trillion yuan a jump that far outstripped analysts
forecasts while the surge in liquidity has pushed up
But economists are increasingly warning about the heightened
risk of bad loans and speculative bubbles in the wake of
resurgent bank lending with record levels of money supply.
Given the surge in bank lending, theres no way it
can be used productively, says Brainard.
And while the recent surge in lending may help Chinas
economy recover earlier rates of growth in the short term, the
surge in lending could also bring with it unintended
consequences: The pace at which banks have been growing
their loan books has been way too fast, says Hu.
There are questions about loan quality: could this sow
the seeds of more non-performing loans [NPLs] going
Managing the flow
How Beijing manages the flow of credit in coming months will be
critical to the countrys growth trajectory. The central
bank has indicated that it will maintain its moderately loose
monetary policy this year to supply ample
liquidity. And analysts believe that the full total of
new loans this year could surge to 9 trillion yuan.
The problem is the rate and breadth of lending: the mostly
state-owned banks in wealthy and poor regions alike are
duty-bound to follow Beijings orders to lend. While
growth in bank credit is both desirable and
necessary, Hu says the government must make sure
this doesnt translate into political pressure to lend.
That would be a recipe for disaster.
The countrys leading banks have all answered the
governments call on new lending. China Construction Bank,
the countrys second-largest commercial lender by assets,
said it will extend 400 billion to 500 billion yuan in new
loans in 2009, an increase of 1315% on last years
levels, and about half of the loans will go to infrastructure
projects. Bank of China, the countrys fourth-largest
bank, will support fiscal stimulus plans by extending at least
300 billion yuan in loans for major infrastructure projects.
But senior officials are also sounding the alarm over huge
hidden dangers that bad loans pose to the overall
financial system in China. The biggest dangers to
Chinas economy and financial system come from within, not
from outside, Jiang Zhenghua, former vice-chairman of
Chinas parliamentary standing committee, said in Beijing
recently. The biggest of these hidden dangers is the
degree of bad loans in China.
Fan Gang, an adviser to the Peoples Bank of China, said
recently that a slight rise in non-performing loans may be
acceptable in the short term. This is a crisis, so a
23% increase in non-performing loans may be OK,
Fan, who sits on the Chinese central banks monetary
policy advisory committee, noted.
So far in 2009, the ratio of non-performing loans among local
lenders has declined to 2.04% from 5.78% a year earlier.
Chinese banks had a total of 549.5 billion yuan ($80.4 billion)
in non-performing loans as of March 31, down 10.7 billion yuan
from the beginning of 2009, the regulator said on April 14. And
the banking industry boosted its assets by 25% to 69.4 trillion
yuan by March.
But the fear is that this number could bounce back as credit
growth surges. As former IMF chief economist Raghuram Rajan,
puts it in an interview with Emerging Markets, many things are
masked by high growth: When it slows sharply, skeletons
Meanwhile the explosive credit expansion has led to a record
25.5% jump in M2 money supply, which includes all cash and
deposits, compared with a government target of 17%. Stephen
Green, head of China research at Standard Chartered, notes that
Chinese monetary policy is caught in a dilemma: tightening too
early could choke off a recovery whereas tightening too late
could run the risk of asset bubbles and excess investment.
The central bank said in the statement that it will
maintain continuity of its present monetary policy and
ensure that money supply is sufficient to meet the needs of
economic development. The surge in bank loans has led to
speculation that policy-makers are stepping up money-market
operations to absorb surplus cash. The central bank drained a
combined 165 billion yuan ($24 billion) through 28- and 91-day
bill repurchase agreements week of April 20, the most in more
than two months.
Hu says that banks need to be more vigilant and to
keep in mind the lessons of the past.
It is a message not lost on the regulators: Liu Mingkang, head
of Chinas banking regulator, said recently that
banks ought to fully realize that dealing with the impact
of the crisis is a long-term task, and should pay close
attention to risks accumulated from a burst of lending.
The central bank, led by governor Zhou Xiaochuan, is also
closely supervising the hidden risk from liquidity
Liu believes the risks are controllable, as banks have recently
been instructed to step up their checks on lending
practices. The banking tzar previously told Emerging
Markets that banks had adequate reserves and
provisions to deal with any possible resurgence of NPLs.
But at a recent conference in Hainan, Liu said that bad loans
will continue falling this year as banks improve their capital
adequacy and increase their scrutiny on lending.
Im being responsible when I say that we will
continue to see declines in both the outstanding bad loans and
the ratio of non-performing loans, he said at the Boao
Forum in April.
Nevertheless, sources say even regulators were caught by
surprise by the surge in recent bank lending.
Chinas government is reportedly considering measures to
regulate the flood of bank lending. The CBRC (China Banking
Regulatory Commission) is looking at rules to ensure loans are
directed at the real economy, such as government stimulus
projects, rather than being diverted into the asset markets or
bank deposits. At the same time, however, the banking watchdog
is moving to ease other restrictions, in an effort to pump more
loans into the rural economy.
Despite the authorities efforts, Chinas economic
rebound could end up a short-lived bounce. For sustained growth
to occur, the economy will need new growth drivers besides
investment or exports. For now, the effects of the investment
stimulus are unlikely to be long term; nor is an export-led
recovery on the cards, given the dire prognosis for global
While there is widespread agreement that part of the answer
must lie in boosting Chinese domestic consumption, turning
Asias traditional savers into consumers is no enviable
task. This rebalancing does not take place over
night, Stephen Roach, Morgan Stanleys Asia chairman
tells Emerging Markets. This is a generational shift, but
it needs to begin now.
Yet its a task thats as urgent as it is formidable,
especially in the wake of a global economic slump. Adds Roach:
There are a lot of moving parts in this