Chinas banks have spent most of the past 18 months
shipping out giant bundles of cheap loans to state firms and
infrastructure vehicles: Rmb9.7 trillion ($1.4 trillion) was
distributed by mainland lenders in 2009 by any standard
a world record with a further Rmb7.6 trillion set to be
shelled out by end-2010.
Such largesse probably prevented an outright recession in
China last year but at what cost? Beijing has only just
begun to tackle a series of interlinked speculative bubbles.
Real estate prices are soaring while inflation is tipped to
rise strongly this year.
In recent months party leaders have belatedly moved to rein
in their banks, partially curbing their enthusiasm for lending.
The two questions on everyones lips now are can they
succeed, and will their measures be enough to stop the entire
Chinese economy suffering its own bone-juddering crash?
First, to Chinas recent austerity measures. So far,
party leaders in Beijing have rolled out a series of systemic
measures designed to rein in credit growth and exert a measure
of control over an economy widely viewed as being out of
control. These include:
Flooding the market. The Peoples Bank of China
(PBoC) has begun to sell more central bank notes to soak up
Raising the reserve requirement ratio (RRR)
the minimum reserves each bank must hold in relation to total
customer deposits. The PBoC has pulled off this trick twice
already in 2010, raising the rate to 16.5% from 15.5%. Expect
more such incremental moves in the future.
Cutting off the money supply. Beijing announced
measures to restrict new lending growth in January 2010, slowly
weaning mainland lenders off their cheap credit fix.
Re-introducing measures designed to stem soaring
property prices. Buyers of second and third homes will be taxed
at a higher rate if they seek to flip their property in a quick
sale, while Beijing will flood the market with new low-cost
housing in an attempt to slowly deflate, rather than pop, the
TOO LITTLE, TOO LATE
Will these measures work or is it a case of too
little, too late? Jim Walker, the founder of Hong Kong based
economic consultancy Asianomics, is dismissive of
Beijings reference to its RRR hikes as liquidity
management. This puts too much of a gloss on what
is actually happening, says Walker. Money and
credit growth are out of control. To avoid an even bigger crash
in two to three years time, Beijing will have to act
forcibly all year.
Chris Palmer, head of global emerging markets at Gartmore,
says: Chinas big challenge is to slow down the rate
of lending at its leading banks without creating a sharp
economic slowdown. This is going to be tricky.
So far, party leaders have chosen to wield the lesser of
their credit-tightening weapons. The reserve requirement ratio
has been inched, rather than ratcheted up, so far. Most expect
that to change.
Kwokon Fung, China equity portfolio manager at Nikko Asset
Management in Beijing, tips interest rates on both lending and
deposits to rise and in a pragmatic but likely
politically charged move for China to allow its
currency, the yuan, to appreciate, freeing it slightly from its
fixed rate against the US dollar. We expect the
government to [also] further increase deposit the reserve
requirement ratio and to continue to slow down new loan growth
and restrict the uses of new lending, Fung says.
Asianomics Walker reckons the RRR will hit 20% by
end-2010, with interest rates being hiked by 200300bp
over the year. That shows how serious the inflation and
mal-investment problems now are in China, he says.
Other analysts see China playing a slower, longer game as it
tries to tamp down its overheating economy. John Vail, chief
global strategist at Nikko Asset Management, believes China
will continue to rely mostly on administrative measures to
tighten credit growth: crimping lending and hiking property
taxes while ordering state-owned enterprises (SOEs) the
cause of much of the recent real estate speculation to
exit the sector.
The key is how aggressively China implements these
measures, says Vail, who reckons an alternative is for
Beijing to realign its currency incrementally against the
dollar. If they are going to start gradually appreciating
the yuan, Chinas leaders will not take too many
tightening measures, as they measure the economic tightening
effect of the appreciation.
China is at a defining moment in its economic history. It
stands at a crossroads with all paths unmarked: Beijing will
have to rely solely on trial-and-error.
Stephen Green, the Shanghai-based head of Greater
China research at Standard Chartered, says that now that
Chinas economic growth is assured, party leaders must
recognize that a fiscal crisis exceeds the risk of a
growth crisis, and move toward stopping, or at least
slowing, the flow of credit through its leading
But how to do this? China is imposing measures on banks
designed in theory at least to cut out any
extraneous lending. But to cut off all new lending growth would
be self-harm. Much of the 2009 loan growth went to
infrastructure projects: cutting off funding halfway through a
project would mean double trouble, a politically undesirable
move that would overnight create a pile of new non-performing
loans (NPLs) for the banks and the state to dredge through.
Yet it seems inevitable that NPLs, the capital scourge of
the late 1990s and the early 2000s, are set to rise again,
perhaps forcing the party to dip into its $2.4 trillion of
foreign reserves, possibly as early as later this year. That
will inevitably lead to the vilification of bank officials by
party leaders and probably a few sackings over
the coming years, probably long before a new generation of
political leaders takes the helm in 2012.
It hardly seems fair to blame bankers or local
government officials for following orders, says Green.
Beijing shouted jump in October 2008 and all local
officials and bankers were expected to respond. This mess was
created the moment the Rmb4 trillion stimulus package was
announced but not funded. The feeling back then was clearly:
Well sort this out when the emergency is
Beijings other big problem is that everything these
days is interlinked. China is no longer an isolated Maoist
state nursing colonial-era grievances: it is a key player on
the global stage. If its overheating economy stutters or
even crashes the effects will be felt around the
Chinas 2009 lending boom has had two other unintended
consequences: high-and-rising property prices, and worrying
signs of upward inflationary pressure.
Much of this is due to the 2008 stimulus package. Banks lent
to city authorities, which in turn parcelled out the cash to
local SOEs. They in turn sank their money into one of the few
financial instruments they understood: real estate
Chinas red-hot property sector is, by any measure, out
of control. Real estate prices in key cities notably
Beijing and Shanghai rose by more than 20% year-on-year
in January 2010, and by more than 50% higher in the southern
coastal city of Sanya. Professionals unable to gain a foothold
on the property ladder are increasingly forced to live in the
outskirts of cities, overpaying for cramped, shared
accommodation, while the SOEs referred to as
Chinas new land kings sit on prime
residential buildings that are kept empty to allow them to be
quickly flipped when a buyer is found.
Amid the many voices describing Chinas property market
as a crash waiting to happen, a few lone clarion voices call
for temperance. Gao Jian, vice governor at China Development
Bank, the countrys leading policy lender, admits to the
existence of a property bubble, but says it is no cause for
major alarm. Rising property prices wont trigger a
financial or economic crisis, he says. China has
learned its lesson from the subprime problems in the US. We
tend to be much more cautious here.
And yet property inflation may just be the tip of the
Food costs have been rising for months due to a drought in
the south-west of the country, while wholesale price inflation
is running at between 5% and 7% in various parts of the
country. Inflation will further undermine Chinas suddenly
wobbly banks not least by creating a new surge of dud
The big trigger for NPLs in the future will be high
inflation, which will ultimately lead to credit ceilings on
banks, says Victor Shih, an assistant professor at
Northwestern University in the US. This will mean that
banks will no longer be able to roll over problematic loans.
Then, we will see a large wave of NPLs.
Party leaders in Beijing face a difficult challenge in
steering the economy with only a few, fairly rudimentary,
credit tightening measures at their disposal. If these
dont work, and the economy continues to overheat
gross domestic product is tipped to rise by upward of 11%
year-on-year in the first quarter of 2010 they will be