The ability of monetary easing to stimulate credit growth in China has diminished and we think this will lead the People’s Bank to pull down interbank rates further than most anticipate. But even this probably wouldn’t avert a further economic slowdown given the recent deterioration in credit allocation.
- The ability of monetary easing to stimulate credit growth in China has diminished and we think this will lead the People’s Bank to pull down interbank rates further than most anticipate. But even this probably wouldn’t avert a further economic slowdown given the recent deterioration in credit allocation.
- The People’s Bank (PBOC) has eased monetary conditions significantly since the beginning of 2018. 3M SHIBOR, a key benchmark for interbank rates, has dropped around 200bps, similar in scale with the declines seen during past easing cycles in 2011/12 and 2014/15. (See Chart 1). But compared with previous rounds of stimulus, the resulting pick-up in credit growth has been lacklustre. In particular, the key driver of China’s credit cycle – non-bank borrowing – has failed to stage much of a recovery. (See Chart 2.)
- Some argue that firms simply have little appetite to borrow, even at lower rates. But we are sceptical. Banks are reporting relatively healthy loan demand (see Chart 3) and there is plenty of anecdotal evidence of firms looking to borrow at affordable rates. Instead, two key factors appear to be dampening the transmission of lower interbank rates to non-bank credit. First, corporate bond defaults have surged during the past couple of years, leading to wider credit spreads. As a result, lower-rated issuers have not seen much of a decline in borrowing costs during the past year or so, in contrast to previous easing cycles. (See Chart 4.)
- Second, access to shadow credit has remained restricted. A tightening of regulations in 2017 made it much more difficult for banks to expand lending off-balance-sheet via shadow-financing vehicles. Growth in banks’ claims on non-bank financial institutions slumped as a result and has remained negative in recent quarters. (See Chart 5.) Data on the cost of shadow financing is sparse, but figures from P2P lenders and regional shadow bankers suggest that borrowing costs have remained elevated during the past year or so and less responsive to monetary easing than in the past.
- PBOC statements suggest that the central bank is aware of these problems but that it is unwilling to take drastic measures to unclog the transmission mechanism. The crackdown on shadow banking has helped reduce some of the vulnerabilities on the funding side of the banking system and policymakers appear adamant not to reverse this progress. If anything, they seem intent on restricting access to shadow financing further, particularly for real estate developers.
- Meanwhile, with economic activity slowing and the share of loss-making firms rising (see Chart 6), credit spreads are unlikely to narrow much in the coming quarters without state intervention that would undermine the recent improvement in the pricing of default risks.
- As a result, we think the PBOC will need to ease monetary conditions more aggressively than most anticipate in order to shore up credit growth. We anticipate a further 75bp decline in 3M SHIBOR in the coming quarters, compared with consensus expectations of an 30bp decline. And even then, we think the resulting pick-up in credit growth is likely to remain modest.
- What’s more, the recent deterioration in credit allocation will dampen the impact of stronger credit growth on economic activity. Policymakers have been trying to nudge banks to lend more to private firms. But these efforts have had limited success. Private firms, which make up the bulk of shadow banking borrowers and low-rated corporate bond issuers (see Chart 7), have benefited least from current round of monetary easing. As a result, the share of credit going to less-efficient state firms has increased, a trend that is evident in the bond market. (See Chart 8.) The upshot is that even if the PBOC eases policy more aggressively than markets expect, this probably won’t be enough to prevent growth from slowing further over the coming year.
Chart 1: 3M SHIBOR (%)
Chart 2: Credit Outstanding (% y/y)
Chart 3: Loan Demand Reported by Banks in PBOC Survey (diffusion index)
Chart 4: Bond Yields (%)
Chart 5: Bank Claims on Non-Bank Financial Institutions (% y/y)
Chart 6: Loss-Making Firms (% of Industrial Firms)
Chart 7: Credit Ratings (% of Outstanding Bonds)
Chart 8: Net Bond Issuance (RMBbn, 12m sum)
Sources: CEIC, Bloomberg, Capital Economics