The world’s central bankers must be a little envious of Zhou Xiaochuan. While they struggle to pump enough money into the financial system to stave off deflation and deleveraging, the People’s Bank of China governor faces the opposite problem.
China’s rapid pick-up in growth – the second quarter GDP number was a solid 7.9% year-on-year, and probably an even better 12% or so using the quarter-on-quarter annualised method that most big economies use – is entirely down to a huge rise in bank lending. In June, banks made RMB1.53trn (US$224bn) in new loans – five times more than the same time last year.
If you think that sounds as though it could turn out badly, I’d agree. Runaway credit growth eventually leads to asset price bubbles, high inflation and bad loans. Investors were ignoring this risk in America for years. Could they be about to do the same with China? Let’s take a closer look …
China has been deleveraging
As you can see below, Chinese bank loans are now up by almost 35% on the year. On the face of it, that’s pretty spectacular growth, but it needs to be seen in context.
Loan growth had run at around 15% in recent years, which was below average nominal GDP growth, unlike most of the world. In fact, China had been deleveraging since 2003, as the chart below from UBS shows.
As a result, China is almost the only country that can employ a countercyclical lending policy – in other words, having restrained lending during the boom, it can now boost loans to help lift the economy through the downturn. In principle, this is a good idea and a far better place to be in than the West, where overextended banks now need to shrink their loan books at just the wrong time.
However, merely dumping more money into the system isn’t very helpful if the extra spending doesn’t do anything productive. This was the mistake that the US made after the dotcom bubble burst – ultra-low rates and lax lending simply inflated the housing bubble. So where is this huge loan growth going?
Investment is surging
The first thing to note is that the growth may be a bit overstated. It’s likely that credit growth ran quicker in 2008 than officially recorded, with banks hiding some of their lending off balance sheet. Now those loans are being brought back onto the books.
Some of the surge may also reflect people and firms who have borrowed from grey-market lenders when credit was tight and can now switch back to mainstream banks. So overall, China may have deleveraged a bit less than it seems, and may now be gearing up less than we think.
But the majority of the new lending is clearly real. And most of it’s going into investment. Fixed asset investment was up 33.5% year-on-year in the first half of 2009. That may have been overstated at first – local officials had every reason to exaggerate what’s being done so that it looks like their region was doing its bit for the economy – but indicators such as steel prices suggest that work is now ramping up.
The big concern here is what return China gets on this investment. Will it be spent productively or will it end up in expensive and unnecessary infrastructure like the impressive but underused Shanghai Maglev train? Will there be yet more investment in oversupplied industries like steel?
Heading in the right direction
Certainly, waste is a real risk. Inevitably, when you throw out this much money this quickly, some will be squandered. But there are encouraging signs. For example, if you look at the fixed asset investment numbers by province, you can see that the biggest growth is generally in the lower income provinces.
Since it’s the poorest provinces that have the greatest need for more investment, this suggests money may be going where it can do the most good over time. (Incidentally, on this chart, red names are eastern provinces, green are central ones and blue are western ones – inequality between the top eastern costal provinces and the rest of the country is enormous, which is one of China’s development challenges.)
In terms of industries, it’s hard to be sure – investment is only broken out in broad categories. But broadly, spending seems to be along the right lines. For example, investment in iron and steel processing is up only 0.2% on the first five months of last year. Computers and electronics manufacturing investment is down 2.6%. On top of this, the government is trying force consolidation in industries like steel and automobiles, which should also help to shut down excess inefficient capacity.
Bubbles are being blown again
However, clearly not all the money is going into investment. Some is clearly flowing out into asset markets – in particular residential property. After a tough 2008, in which many small developers collapsed and – according to rumour – a number of large ones needed government help, the sector is rebounding. Nationwide, prices are up again year-on-year, as you can see below.
The turnaround has been even more dramatic in the worst-hit markets, such as Shenzhen, as this chart shows.
Still, Chinese property definitely seems to be a tale of two markets. Sales in mass-market housing have recovered, but there’s little sign that developers have recovered much pricing power.
However, it’s a different story in higher-end residential, which was the segment that saw the most speculative excess and was hit hardest price-wise when the government clamped down on real estate lending in late 2007. Here, the market has sprung back from the dead.
When you read about queues around the block to view a new development and 20% price rises since April in Shanghai and Shenzhen, we’re talking about this segment. Gains need to be seen in the context of what went before – prices for some developments fell by 50% or so during the slump – but there’s clearly a lot of speculation in the market again.
And it’s the same in the stock market. The CSI300 benchmark is up more than 150% from its lows, while trading volumes are running at three times the level of last year, as you can see below. This week, the initial public offering for Sichuan Expressway – the first company to float on the mainland market for ten months – was 414 times oversubscribed.
That definitely sounds like irrational exuberance. And looking at that chart, the CSI300 is showing the classic post-bubble pattern. The crash is followed by a strong rally that convinces everyone the bull market is back on. Then it runs out of steam as quickly as it began. Normally, you’d expect it to burst any time now.
The lending boom will continue for now
However, China’s economy is always difficult to analyse, because it remains a combination of a state-directed company economy and a market economy. That makes it very hard to say what will happen in these credit-fuelled stock and property market recoveries.
Since the government is still telling the banks to lend, credit growth is likely to remain strong for the next few months. In particular, the fact that October is the 60th anniversary of the founding of the modern Chinese state suggests that they are unlikely to risk tightening credit and slowing the economy too much before that important date.
The China Banking Regulatory Commission (CBRC) is warning that loan growth is too fast and that banks must be more careful about the quality of projects they lend to. In a sign that they are especially worried about property speculation, lending for second mortgages was singled out as an area to watch. But the CBRC has limited power to intervene, given that the order to boost lending comes from the top of the government.
We may see some efforts to tweak lending and restrain a few overheated areas. But on the whole, major changes look unlikely until the world economy starts to improve or inflation looks like a problem. It hard to see either of those factors coming into play until early next year; as the chart below shows, while prices are probably stabilising, inflation isn’t a big risk yet.
Still, investors should be cautious. If someone tries to sell you an investment property in Shanghai, you should promptly show him the door. (Mind you, I’d say that at any time – generally, investing in property is better done through liquid, listed, diversified vehicles like real estate investment trusts than by buying a single apartment yourself.)
And if you’re trading the mainland Chinese market through one of the handful of ETFs that invest in it, you should be prepared for a sudden slump at any point. Investors in Chinese stocks listed elsewhere – such as Hong Kong – are in a different situation, as these markets don’t march in lockstep with the mainland and haven’t rallied so rapidly in any case. However, they’d probably see a lot of turbulence if the mainland sold off hard.
No need to worry yet – but keep an eye on credit
But while we are clearly seeing the property and equity bubble reinflating a bit, I don’t think this is too worrying for now. As intended, the lending boom is giving a boost to the Chinese economy; some leaks into asset markets are inevitable.
As longer as China begins tightening again once the job is done, the impact should be pretty limited and the bubbles come back under control. The government was aggressive in popping the property bubble back in 2007/2008 – it’s unlikely they’ll spare it this time round once the economy is back on its feet.
The big risk is that China decides not to tighten and credit growth continues to run away through 2010 and longer. In that case, we could end up with unbalanced growth and major asset bubbles – in short, a replay of what has just happened in the West.
I think this is unlikely and in any case, it’s too early to worry yet – this would play out over several years. But obviously we will need to keep an eye on this over the long term to make sure the China boom doesn’t turn into a bubble.
In other news this week …
|China (CSI 300)||3,520||+3.6%|
|Hong Kong (Hang Seng)||18,806||+6.2%|
|Singapore (Straits Times)||2,431||+5.3%|
|South Korea (KOSPI)||1,440||+0.8%|
|Vietnam (VN Index)||429||-2.4%|
|MSCI Asia ex-Japan||401||+5.0%|
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