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 bottomed out.
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 country’s 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.
Today’s slump is easily the country’s worst since the downturn of 1989–90, when the economy grew at 5%. It marks an immense plunge from past growth that hit a record 13% in 2007.
But growth estimates are now being widely revised upwards. China’s central bank says the country is on track to hit the government’s target of about 8% this year. Private forecasters are also changing their tune: Goldman Sachs reckons China’s 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.
It’s 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 world’s 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 China’s 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 Sachs.
But he cautions against reading too much into the recent data. “This doesn’t 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 adds.
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. “We’re looking more at a ‘W-shaped’ recovery, not a ‘V’” says Brainard. “To have sustained growth, China needs to have domestic demand. That’s what’s necessary to rebalance the economy.”
Last September, in response to global financial shockwaves, the People’s 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 China’s 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 that’s already pushing Beijing’s target of 5 trillion yuan ($731 billion) of new loans for the whole of 2009.
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 stocks.
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, there’s no way it can be used productively,” says Brainard.
And while the recent surge in lending may help China’s 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 forward?”
Managing the flow
How Beijing manages the flow of credit in coming months will be critical to the country’s 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 Beijing’s orders to lend. While growth in bank credit is both “desirable and necessary”, Hu says the government “must make sure this doesn’t translate into political pressure to lend. That would be a recipe for disaster.”
The country’s leading banks have all answered the government’s call on new lending. China Construction Bank, the country’s second-largest commercial lender by assets, said it will extend 400 billion to 500 billion yuan in new loans in 2009, an increase of 13–15% on last year’s levels, and about half of the loans will go to infrastructure projects. Bank of China, the country’s 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 China’s economy and financial system come from within, not from outside,” Jiang Zhenghua, former vice-chairman of China’s 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 People’s 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 2–3% increase in non-performing loans may be OK,” Fan, who sits on the Chinese central bank’s 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 get unearthed.”
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.
New rules
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 China’s 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 expansion.
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.
“I’m 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.
China’s 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.
Growth driver
Despite the authorities’ efforts, China’s 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 demand.
While there is widespread agreement that part of the answer must lie in boosting Chinese domestic consumption, turning Asia’s traditional savers into consumers is no enviable task. “This rebalancing does not take place over night,” Stephen Roach, Morgan Stanley’s Asia chairman tells Emerging Markets. “This is a generational shift, but it needs to begin now.”
Yet it’s a task that’s 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 transformation.”