A credit boom in China failed to keep economic recovery on track in the first quarter, suggesting the cash sloshing around the economy is not yielding the desired effect of stoking growth and could instead exacerbate property and inflationary risks.
A rapid rise in credit in recent months has been driven by the fast-growing shadow banking sector rather than formal bank lending, raising two major concerns.
One is that some of the new money is being used by debt-laden local governments to repay existing loans rather than being channeled into investment that might spur fresh economic activity.
The second is shadow banking has provided a lifeline to funding investment in the property sector, one area where the government is trying to restrict growth for fear that a house price boom could undermine the broader economy.
“Local governments face difficulties in getting bank loans, so they have turned to short-term shadow financing,” said Xu Hongcai, senior economist at China Centre for International Economic Exchange, a government think-tank in Beijing.
“The government may have to rein in the rise in social financing later this year,” he said.
Meanwhile, China’s manufacturers – the pillar of the economy – are reluctant to borrow and step up capital spending given persistent overcapacity and an uncertain growth outlook, effectively a drag on future potential growth.
Data on Monday showed that China’s annual economic growth slowed to 7.7 percent in the first quarter from 7.9 percent in the previous quarter, confounding market expectations that the credit surge would lead to a pick up in the pace of the recovery in the world’s second-largest economy.
Adding to worries about the property sector, real estate investment expanded 20.2 percent on a year earlier, while revenues from property sales rose 61.3 percent.
Average new home prices in 70 major cities climbed 2.1 percent year-on-year in February and were in double digits on a weighted basis in many, forcing the government to launch a new round of measures to cool them.
“People are snapping up property. We are watching whether the government is able to put a lid on housing prices,” Zhu Baoliang, chief economist at the State Information Centre, a top government think-tank in Beijing.
Still, the rise in property prices and surge in credit in the economy has yet to translate into any significant increases in official consumer inflation, although analysts suggest price pressures are building.
Consumer inflation eased from a nine-month high in February to 2.1 percent in March, well below the government’s 3.5 percent 2013 ceiling.
The central bank’s broad measure of liquidity – total social financing (TSF) – jumped nearly 60 percent in the first quarter from a year earlier to a staggering 6.16 trillion yuan ($1 trillion). That compares with 15.8 trillion yuan for all of 2012.
However, the proportion of TSF from formal bank loans shrank to below 50 percent. It was over 90 percent a decade ago.
Components of off-balance sheet financing soared though. Trust loans and entrusted loans posted sequential growth of 360 percent and 86.3 percent, respectively.
Since the lending is off-balance sheet it is more difficult to detect and has been used by local governments and property companies to finance projects as the government has tried to tighten formal bank loans to control construction and public spending by regional authorities.
There are signs that many local governments are also using proceeds from bond issuance and other short-term financing to service their existing debt.
Jilin Provincial Expressway Group announced in February that it will issue 970 million yuan of notes and use the proceeds to repay bank loans. In January, Shaanxi Expressway sold 3 billion yuan in notes and used half the proceeds to repay loans.
“There could be distress among some borrowers, especially local government related entities, and some new credit may have been used to service the existing debt instead of being channeled to actual investment activities,” Tao Wang, China economist at UBS, said in a research note.
Global ratings agency Fitch cut China’s long-term local currency credit rating by a notch to A-plus last week, citing financial risks from rapid credit expansion alongside the rise of shadow banking activity.
It estimated that local governments are saddled with nearly 13 trillion yuan in debt in 2012, or a quarter of GDP. Government data put local debt at 10.7 trillion yuan in 2010.
Moody’s Investors Service on Tuesday affirmed China’s government’s bond rating of Aa3 while cutting the outlook on it to stable from positive, a move that clearly states the potential for an upgrade has evaporated.
TRICKY POLICY BALANCE
Annual economic growth may rebound to just over 8 percent in the second quarter, Zhu at the State Information Centre predicted. But analysts say a sharp turn-around looks unlikely given doubts about how credit is being used.
The weaker-than-expected first-quarter growth data has prompted some analysts to cut their 2013 outlook. JPMorgan Chase has cut its 2013 GDP forecast from 8.2 percent to 7.8 percent, albeit still higher than the official target of 7.5 percent.
“As the structural adjustment in the economy goes on, over-capacity in a number of industrial sectors remains overwhelming, restraining the pace of cyclical recovery,” JPMorgan chief China economist Haibin Zhu said in a note.
That hampers their demand for bank credit.
Chen Letian, an economist at Rising Securities in Beijing, estimated that the average factory capacity utilisation rate in China was just 57 percent in 2012.
Chinese leaders may tread cautiously to balance the need to support growth while keep property and inflationary risks at bay, analysts say.
They said ample credit supply suggested monetary policy may still be loose, even though the central bank describes its stance as neutral.
“We believe the government will likely keep policy relatively loose. However, given concerns on property prices and leverage level, among others, large scale stimulus is unlikely to occur,” Yu Song, China economist at Goldman Sachs, said in a note to clients.
(Editing by Neil Fullick)