Credit concerns have become real. Chinese banking assets have increased by $15,400 billion (140% of GDP), from 2009 to 2013, reaching the astounding sum of $24 trillion. The phenomenon has also involved loans amongst the private sector, as know as peer-to-peer (P2P) loans, which amounted to $940 million in 2013. Analysts forecast the level hitting $7,800 billion by 2015. A significant percentage of the companies financed by banks do not have a sustainable business plan. 58 companies out of 1000 have already declared bankruptcy in the last quarter of 2013. Xu Hongawei, the Head of the Online Lending House, foresees 80%-90% of the companies are in serious danger.
China’s National Audit Office stated that local government obligations hit 17.9 trillion Yuan ($3 trillion) by the end of June – a dramatic increase from the 10.7 trillion Yuan figure reported in 2010. The Audit Office said that debt levels are still controllable, echoing the statements of top Communist Party officials in recent months. At the end of 2013, The People’s Bank of China (PBoC) lent 255 billion Yuan to Chinese banks to contrast the ongoing “credit crunch.” The amount is to be considered relatively significant, considering that the central bank usually tries to absorb excess of liquidity from the market in that period.
However, this time, the maxi-loan was due to the anxiety to see many institutions dragged down by increasing overnight interest rates, which signal lack of confidence among investors, especially in the short-term money market. Interest rates significantly decreased after the announcement, the daily and weekly interest rates dipped to 3.50% and 5.25%, respectively. PBoC also guaranteed emission of loans up to two weeks to minor institutions, through the Standing Lending Facility.
However, this loan is unlikely to be sufficient to avoid, by itself, the Chinese credit crunch. Many institutions and companies risk bankruptcy. The status of danger was clear even before the PBoC intervention; the official magazine of the regime, the China Securities Journal, warned about the increasing cost of funding. Chinese private sector debt surpassed 200% of GDP. Markets have demonstrated twice in 2013 to be incapable to thrive without central bank’s support. In June first, and then in September again, PBoC tried to regulate abundance of liquidity, having as a result an interest rates’ boom, which jumped immediately to 30%.
The rates at which China’s banks lend each other money have been extremely low in recent years – something that helped fuel the shadow banking boom. That’s beginning to change, in no small part due to the People’s Bank of China, which has periodically allowed rates to rise dramatically before warding off a credit crunch with a cash injection. Higher lending rates should put the screws to lenders in the shadow-banking sector. By allowing rates to rise, the central bank is encouraging lenders to be more responsible with their asset management strategies. But the central bank must work to avoid a true credit freeze – an event in which banks hoard cash and refuse to lend to each other. Nobody wants this.
What’s next for the PBoC?
There are multiple objectives for monetary policy, with different priorities at different times. The PBoC has on its mandate the following: stable inflation, GDP growth, full employment and balance of international payments, but also financial stability and facilitation of economic reform, as PBoC governor, Zhou Xiaochuan, elaborated on in May. At a particular time, the central bank has to make a balancing act because some of these goals may conflict with one another. In view of the high leverage in certain industrial sectors and local governments, the PBoC shares the concern that an across-the-board easing is likely to increase leverage further, leading to more financial risks and a possible delay in reform. Having said that, with the mandate of stabilising growth and maximising employment, the PBoC has to fine-tune its policy to avoid further deterioration in growth, with may ultimately cause stress in labor market.
Both quantitative and price-based (interest) tools in monetary policy have seen diminished effectiveness in the transmission mechanism. Effectiveness of quantitative policy tools has already declined, due to the rapid financial innovation in recent years. The role of interest rates is also undermined, due to the soft financial constraints on many borrowers (mainly SOEs and local government’s financing vehicles) with inelastic demand for credit. Policy makers believe they can differentiate the impact of monetary policy measures on different sectors.
To optimise the credit structure, targeted easing measures are designed to direct additional funding to the much-needed fields that are critical to support growth and employment – primarily agriculture, public housing and SMEs (Small and Medium Enterprises). As such, these should avoid channeling liquidity into sectors over-capacity or low efficiency. The re-lending to China Development Bank (CDB) provides financing for public housing construction, raising the debt for the central government while offsetting the slowdown in private property investment and manufacturing investment. The RRR cuts for quantified banks with a focus on serving SMEs are aimed at alleviating the financing difficulties for SMEs; with contribute to around 80% of employment.