China's lending binge may not improve its economic prospects

Photo by Kevin Frayer/Getty Images

Chinese banks took lending to unprecedented levels in January, extending a whopping 2.51 trillion yuan in new credit, the largest monthly total on record.

The lending boom, while improving the near-term prospects for economic growth, revived simmering fears over the degree of leverage within China’s banking system.

While the headline increase provided both fuel to the China bears and bulls, Jing Li and Julia Wang, economists at HSBC, believe that there were unique circumstances that led to the huge splurge in lending in January.

“While continued easing of mortgage policies may have pushed up household loans, the strong corporate lending may be more related to companies shifting out of FX liabilities into RMB debt amid exchange rate fluctuations,” said Li and Wang. “Therefore, today’s data do not necessarily signal a pick-up in underlying credit demand.”

The chart below, supplied by HSBC, reveals the breakdown in new lending seen during the month.

As it reveals, while lending to households rose to 608 billion yuan, up from 319 billion yuan in December, a huge surge in lending to corporates – some 1.94 billion yuan from just 511 billion yuan in the prior month – was largely responsible for the surge in lending seen over the month.

In the wake of recent volatility in the USD/CNY exchange rate, Li and Wang suggest that a large proportion of the lending to corporates was devoted to refinancing domestic-based foreign currency denominated debt.

“We calculated that re-financing domestic USD-loan alone would have boosted RMB lending by RMB700-800bn. Re-financing external debt with domestic RMB loans likely consists of a bigger portion of the lending, but here the statistics are quite lagged,” wrote the pair.

In their opinion, with a large chunk of the new lending merely devoted to refinancing existing corporate debt, it does not automatically signal a meaningful increase in new credit issuance, ensuring that near-term risks for economic growth remain to the downside.

“Recent economic data, including trade data released on Monday and manufacturing PMIs released early this month all pointed to both an uncertain external demand outlook as well as sluggish domestic demand,” say Li and Wang. “Risk to growth therefore remains on the down side, which means that more growth-supportive policies are still highly warranted.”

In response to those building risks, HSBC forecasts that the PBOC will cut official one-year interest rates by 50bps, and reduce the reserve requirement ratio for banks by a whopping 400bps, over the course of 2016.

Along with that, Li and Wang suggest the upcoming National People’s Congress meeting – expected to begin in early March – will see more growth supporting policies being announced.

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