China's loan growth's mind-numbing

Even to economists long inured to humungous statistical numbers coming out of China, the latest official data —— for new loans issued by commercial banks in June — is a staggering monstrosity.

On Wednesday, China’s central bank, the People’s Bank of China (PBoC), announced that new loans issued in June rose to 1.53 trillion yuan (about $224 billion). That’s the equivalent of 1,177 yuan in new loans during the month for every man, woman and child in China!

This frenzy of lending in June brings aggregate new lending in the first half of 2009 to 7.47 trillion yuan (over $1 trillion), up 200% year on year from the first half of 2008, and well above the official full-year target of 5 trillion yuan. “Given the strong momentum, and if no curbs are imposed later in the year, total new loans for 2009 could easily surpass 10 trillion yuan,” says Moody’s Economy.com economist Sherman Chan.

Such limitless liquidity, which is a luxury compared with the credit squeeze in developed economies, has served to keep China’s economic engines humming. “The rapid pace of credit creation has had a stirring impact on China’s corporate sector and asset markets, helping to support domestic demand,” notes JP Morgan chairman of China equities Jing Ulrich. “With liquidity so abundant and inflation expectations supporting a return to real assets, the domestic engines of growth are clearly pulling their weight.”

But increasingly, concern is mounting that this unchecked gush of easy money could lead to a colossal asset bubble in the property and stock markets, and an excruciating bad-loans hangover for banks, which in turn could be a drag on GDP growth for years.

“Credit growth… may have become faster than desired, and concerns that it is getting out of control are intensifying,” observes Chan. “Policymakers need to monitor credit growth to avoid the emergence of downside risks.” Although strong liquidity is crucial in building a short-term boost to the economy, “it may also result in long-term pains for the banking sector if lax credit assessments lead to a rise in bad loans,” she adds.

There is growing evidence that “a sizeable share of credit is funding speculation in equities, property and commodities,” says RBS economist Ben Simpfendorfer.  

This raises concerns that the recent sharp spike in equity and commodity prices, and a recovery in property prices, “is more a signal of easy credit rather than a genuine improvement in the underlying economy,” he adds.

Last month, Wei Jianing, an economist associated with the State Council (the Chinese equivalent of the Council of Ministers), estimated that some 20% of the credit growth had been channelled to the equity and property markets and an additional 30% into other financial assets, including commodities.

In contrast, small- and medium-sized enterprises (SMEs) are still starved of credit, points out Simpfendorder. China’s Minister of Industry and Communications Li Yizong recently said that SMEs, which account for over 50% of China’s economic output (and an even larger share of employment), accounted for just 5% of the total credit growth during the first five months of 2009. “We are concerned about the allocation of bank lending, as SMEs continue to be underserved by the formal financial system,” says Ulrich.

Simpfendorder believes that policymakers’ excessive preoccupation with posting 8% GDP growth is leading to distortions in fiscal and monetary policy-making and worsening economic imbalances. “The 8% target will likely be met in the second half of 2009, but it encourages policymakers to focus too heavily on the pace of growth, rather than the quality of growth,” he adds.

“It is possible,” says Simpfendorfer, “that officials have underestimated the scale of the structural adjustment needed as the economy reorients away from manufacturing and external demand.”

He expects manufacturing slack will drag on business investment and GDP growth through 2010, and “officials, surprised by the weakness in growth, may react by targeting even stronger investment in the heavy-industrial and property sectors in order to reach their 8% growth target.”

His recommendation: “It is time to lower the GDP growth target or eliminate it altogether.” Policy must focus, he says, on the quality of growth, rather than the pace of growth. “It must focus on reducing the economy’s reliance on external demand and manufacturing, for which a reform of the service sector is critical.”

For now, however, there may be no stopping this flood of liquidity. “Quite extraordinarily, despite all this lending, there is still a tonne of sterilised money still sitting, ready to be released in the event of any tightness appearing in the market,” says Standard Chartered economist Stephen Green. “There is no technical reason why loan growth has to slow; the system in theory could maintain 10 trillion yuan loan growth this year and the next.”