Time to Reevaluate China's Loose Credit Policy

By EO Editorial Board
Published: 2009-07-15

Cover Editorial - EO print edition no. 427
Translated by Zhou Yuning
Original article:

1.53 trillion yuan of new loans were released in China last month, driving total new lending for the first half of the year to a record 7.73 trillion yuan, a figure that surpasses total lending in any of the past 60 years.

As many experts have noted, although this drastic surge in lending may help to dispel any prospect of deflation, the government's policy of driving investment and expanding domestic demand to achieve the goal of maintaining a GDP growth rate of 8 percent, has led directly to a blow out in credit that has itself led to unforeseeable risks.

The majority of loans released in the first half of the year were devoted to large government infrastructure projects, investment in railways, highways and airports. In order to help local governments share in the benefits of the 4-trillion-yuan stimulus package, some banks even lowered their lendingrequirements.

While, in the short term, these loans have helped finance large-scale government projects, once the economy has recovered and is back on a path of stable growth, the special "bank-government" relationship forged during this recession, will likely create challenges.

The yields on some local government investments have been relatively low, are spread out over a long period and future repayments of principle and interest are difficult to guarantee. At the same time, most of the loans have been guaranteed by the government.

So, if local governments find themselves in financial difficulty, it's possible that the danger of banks being weighed down with bad loans that emerged in the '90s might reappear.

However, the real danger is not connected to investment in large-scale government projects. It's that half of the new loans have flowed directly into the financial system, rather than being injected into the real economy.

According to Wei Jianing, the deputy director of the State Council Development Research Center's Macroeconomic Department, in the first half of 2009, 20 percent of credit flowed into the stock market while another 30 percent were churned through the commercial bill market.

The basis of China’s economic recovery is still not stable. The 30 percent increase in investment from January to May, has only managed to drive the industrial value-added growth rate up by eight percent. Meanwhile, external demand remains weak, with exports falling 28 percent compared to the same period last year.

Moreover, Chinese retailers and distributors are still reducing inventory and the rise in lending has potential to further expand manufacturing output, which in turn means that the pressure created by problems of overcapacity is likely to increase in the future.

In addition, asset prices have begun to rise. While consumer prices continue to decline, the real estate market has risen so dramatically that the prices of properties in Beijing and Shenzhen have registered record highs. The Shanghai Composite Index has rallied approximately 80 percent.

All this data indicates that the inflated asset prices that emerged in 2007 are about to reappear. However, at that time China's economy was growing rapidly, while now, growth is slow and only slowly beginning to build momentum.

Overvalued asset prices present the illusion of prosperity, they also add volatility to the financial market and have a negative influence on growth in the real economy. When the bubble finally bursts, the real economy will suffer the negative effects along with the banking and financial system.

It is universally acknowledged that increasing internal demand, and more particularly, domestic consumption, is the engine needed to power the steady growth of China's economy.

If too much capital is invested into the asset markets, instead of encouraging spending, this will only reduce the amount of money available for consumption.

As a result, we believe that now is the time for the authorities to reassess their macroeconomic policies.

Rather than simply stop providing stimulus to the economy, we advise that policy makers should moderate the amount of stimulus being introduced and also the approach used to promote growth.

Faced with the recent surge in asset prices, monetary and credit policies should also be adjusted but of course, room should be left for further adjustment.

We noticed that regulators have also begun taking a cautious approach and are now paying attention to potential risks.

An official from China's Banking Regulatory Commission revealed that in an effort to reduce the concentration of loans in particularly sectors or projects, they are now promoting syndicated loans.

A market for the transfer of loans is also to be introduced, this will allow loans to be transferred among different banks so as to further disperse risk.

When the central bank resumed issuing one-year bills last week, they also indicated that a slight adjustment in macro policy had been made. Their attitude toward the expansion of credit has shifted, while in the past they regarded it as a necessary measure required to stimulate the economy, they're now beginning to worry about excess liquidity. 

Of course, the fundamental problem is how to channel loans into the real economy, so that they flow to those sectors of the economy that will be able to contribute to an economic recovery.

When considering whether to tighten or loosen credit, policy makers should pay even more attention to the problem of finding a way to direct credit allocation more effectively, they should also be on guard against the continued swelling of asset bubbles.