Chinese policymakers are trying to engineer a soft landing, and in part are targeting financial... [+]
It was just a matter of time until the relentless pressure imposed by Chinese regulators on the shadow banking system took their toll on the country’s financial system. In the aftermath of Fed Chairman Ben Bernanke’s game-changing press conference in which he unveiled plans to draw-down quantitative easing, interbank lending rates in China spiked, raising the financing costs dramatically which will ultimately force deleveraging across the system. Interestingly, this is a self-inflicted wound, as the administration of Premier Li Keqiang attempts to tackle the problems that could lead to a financial crisis.
With global markets in hurried retreat, and U.S. stocks taking it on the chin, short-term borrowing costs in China surged dramatically. The 7-day repo rate jumped to a record 12% while the overnight repo hit 25%. China’s liquidity crunch is most definitely underway.
It has been for a few months now, according to Nomura, which began warning of the downside risks to the Chinese economy back in March. In their attempt to clamp down on the massive, and growing, shadow banking system, the new administration has pushed total social financing dramatically down, from $410 billion in March to $200 million in May, Nomura’s data. Manufacturing has contracted for two consecutive months, HSBC's PMI data revealed on Thursday, as the index hit nine month lows.
Credit growth is out of control in China, where it’s currently twice as big as GDP and growing twice as fast. As I previously reported, overall credit has grown from $9 trillion to $23 trillion in the five years since the implosion of Lehman Brothers, with credit-to-GDP going from 75% to about 200%. About $5.6 trillion of that represented non-loan credit, with nearly $2 trillion extended by opaque non-bank financial institutions. According to Fitch, more than $2 trillion in credit is connected to informal securitization of bank assets in so-called wealth management products (WMP).
“China is displaying the same three symptoms that Japan, the U.S., and parts of Europe all showed before suffering financial crises,” Nomura’s research team noted, “a rapid build-up of leverage, elevated property prices, and a decline in potential growth.”
Indeed, the current administration has acknowledged this, and is therefore clamping down on the shadow banking system, understanding the trade-off between short- and longer-term objectives. In terms of the liquidity crunch, it was in great part a consequence of the People’s
Growth is slowing, with a 30% chance that GDP will fall below 7% this year Nomura's numbers suggest, but the administration believes it still has room to go before causing permanent damage. At the same time, labor market conditions remain tight, with undersupplied urban labor markets in the first quarter and the first decline in the working-age population in 20 years in 2012. At the same time, the PBoC is taking into account the Fed’s tapering, and has tried to get ahead of the curve in other to minimize dual shocks. The PBoC is committed to Premier Li’s policy of clamping down on financial excesses in the economy.
China’s liquidity crunch will most definitely cause some pain, but investors can’t expect a full-blow Western style financial crisis. While in the U.S., the government was forced to bailout the likes of
We expect a painful deleveraging process in the next few months. Some defaults will likely occur in the manufacturing industry and in non-bank financial institutions. In particular, we see risks in local government financing vehicles, trust companies, property developers, credit guarantee companies, and leveraged manufacturers in industries with over-capacity problems. The non-performing loan ratio will likely rise, and we expect GDP growth to trend down to 7.2% y-o-y in Q4.
An attempt at correcting deep and dangerous financial imbalances in China should positive in the longer-run. While the government may change its course if the economy slows too much, or if the labor situation ends up looking worst than expected, the government’s intention to tackle the growing monster that is the shadow banking system could prove to be the right one to go from a credit-expansion model of growth to a more sustainable one backed by domestic demand. Going too hard too fast, though, can hurt more than it fixes, particularly given the complexity and leverage of the shadow banking system.
