US officials seem to think they have the upper hand in trade talks with China because its economy is struggling. Judging by the string of measures they’ve recently announced to shore up growth, Chinese officials may privately agree. The trouble is, such measures aren’t going to work as fast or as well as markets seem to think they will.
China’s growth woes are homegrown, not the result of US tariffs. Two factors are largely to blame: the government’s concerted effort over the last five quarters to tighten credit and stabilize China’s debt levels, and, relatedly, a dramatic drop-off in investment spending by local governments.
Chinese leaders should always have expected their deleveraging campaign to cut into growth. Some pain is necessary if they’re to reduce the risk of a financial crisis. Even as officials loosen up a bit, they’ve so far resisted the kind of all-out stimulus the government has unleashed in past cyclical downturns.
What that means, though, is that new policies are battling old ones. Months of exhortations from party leaders about the need to deleverage have understandably made banks skittish about lending. Regulatory oversight remains intense: In the first six months of this year, China’s banking regulator fined 798 different institutions a combined 1.4 billion yuan (around $204 million). What’s more, the regulator banned 175 people from the banking industry -- a level of individual scrutiny that has to worry loan officers.
While the government has given window guidance three times in the last month for banks to pick up the pace of lending, bank officials aren’t responding. The pace of overall credit creation has continued to decelerate, despite dramatically lower money market rates throughout July and August. The central bank stepped up liquidity support for the banking system in that period, driving down bank funding rates, as measured by the seven-day repo rate, a substantial 48 basis points. Yet banks have continued to invest primarily in low-risk assets such as government bonds.
The slight boost to bank lending that’s been achieved has been more than offset by the government’s ongoing clampdown on shadow banking. July was a case in point. Growth of outstanding bank lending improved to 13.2 percent year-on-year, from 12.7 percent in June. But all other forms of credit decelerated, growing at a dismal 2.8 percent year-on-year and leading total credit growth to slow for the eleventh consecutive month.
In fact, had the central bank not changed its methodology for calculating total credit, July would have seen the weakest total credit growth on record. With nonbank credit likely to bounce along in this low-single-digit range, bank lending would have to accelerate up to 15 percent year-on-year in order for overall credit growth to improve materially. China hasn’t seen that kind of bank loan growth since a credit blowout in the first quarter of 2016.
Policymakers haven’t made their task easier by trying to direct new lending toward small and medium-sized enterprises. In mid-July, the People’s Bank of China lowered the collateral requirements for its medium-term lending facility, so that smaller banks could use lower-grade corporate bonds to obtain central bank funds. The PBOC’s hope was that banks would use the proceeds to offer more credit to small companies, which officials say account for 80 percent of China’s jobs and 60 percent of gross domestic product.
To borrow a phrase, though, hope isn’t a strategy. Chinese banks simply prefer lending to larger, state-backed companies. This is a structural problem. The banking system remains dominated by the five largest state-owned banks, which don’t have the capacity to delve into credit checks on small businesses; their purpose is to make big loans to big companies. Meanwhile, smaller local banks are typically owned by local state-owned enterprises, which lay claim to the bulk of their loans.
Smaller businesses are more likely to default; bank officials, worried about being held accountable if loans go bad, are thus reluctant to lend to them. Loans to such businesses account for only a quarter of outstanding bank credit. Trying to change that through various administrative decrees or marginal adjustments in incentives simply won’t work.
On the fiscal side, Chinese authorities are looking to cut taxes, allow companies to claim deductions for R&D expenses and accelerate the issuance of special construction bonds by local governments. Only the last measure will do much to address the slowdown in infrastructure spending.
Officials in Beijing have asked local governments to issue up to 80 percent of the remaining 1 trillion yuan of special bonds that fall within the annual quota by the end of September, with the balance to be issued by the end of October. To facilitate the purchase of those bonds, the PBOC is set to lower the risk-rating of local government paper, so banks don’t need to set aside as much capital when buying them.
Just as much as bankers, however, local governments have been cowed by much tougher oversight in the first half of this year. Central authorities shut down a spate of projects that were found to be unviable and have instituted a new rule that local officials will own lifetime responsibility for the debt loads of their jurisdictions; that dramatically shrinks their appetite for risk.
And regardless, in an economy that spends over 17 trillion yuan on infrastructure each year, the remaining special construction bonds represent less than a month’s worth of spending.
Such measures simply aren’t enough to spark China’s giant economy. They’re more of an insurance package -- an effort to limit the downside for growth, especially given the added economic uncertainty of the trade war. Markets would be wise to adjust their expectations accordingly.
By Andrew Polk
Andrew Polk is a founding partner of Trivium/China, a Beijing-based research firm. -- Ed.