(JPM) Amid the surge in bank lending since late last year as Chinese authorities focused on easing overall monetary conditions to support economic growth, concern is rising about a potential credit bubble, banking sector’s asset quality and aggressive policy tightening ahead. New loan creation during the first half of this year totaled RMB7.4tn, compared to RMB4.9tn during all of 2008. However, the market seems to be over-concerned in our view. In fact, new deposits also jumped this year at RMB10tn in 1H09 and loan/deposit ratio remained largely stable and hovered around the decade low. Hence, leverage in the banking system remains moderate despite the surge in loan growth. In particular, a significant part of the new loans created in 1H reflects front-loading by banks or corporate arbitrages, which has come back to banks as deposits and not been used. Overall, we believe a credit bubble is not yet there in China and loan growth will slow naturally in 2H. Hence, policymakers are unlikely to significantly alter their accommodative stance so long as the export engine is still sputtering and inflation pressures remained subdued. We believe that the monetary normalization/tightening process is unlikely to kick in until at least next year.
Credit bubble is not there yet
The credit boom this year was significantly tilted towards the corporate sector.We believe that a significant part of new loans extended this year to the corporate sector has been parked as deposits back into the banking system. Indeed, despite a sharp decline in corporate profit (down 22.9%yoy in Jan-May09), corporate deposits still rose a strong 31.1%yoy by end of June. The increase in new deposits from the corporate sector (RMB5.9tn) in 1H09 was quite comparable to the amount of new loans extended to this sector (RMB6.3tn) during the same period. While many suspect that corporates have been using bank loans for stock market speculation, the size is unlikely to be large.
The new loan creation figure this year was significantly magnified by surging short-term bill financing, which came in at RMB1.7tn in 1H09 but was almost zero during the same period in the previous two years. There has been strong demand from the corporate for bill-financing, given the low rates on bill discounting. The rate was market-based and has fallen sharply from unattainably high above 6% in 1H08 and 2-3% since 4Q08, given the flushed liquidity situation this year. As the deposit rate is slightly higher than the bill discounting rate, many found it profitable to arbitrage the difference in rates. Bill-financing ultimately reflects inter-bank risk and the maturity date is typically no more than 3-4 months. Hence, its credit risk is rather low. Excluding bill-financing, new loan creation was around RMB5.7tn, which is more reasonable compared to the RMB4.3tn created in the full year of 2008 and indeed consistent with the booming economy.
A key focus of new loan extension in 1H09 has been public sector infrastructure projects under the government’s fiscal stimulus package. Those projects are generally backed by an implicit government guarantee and are perceived to be low risk by banks. To compete for such loans, banks have been front-loading their loan books even before these projects kicked off. As a result, much of the already-made loans have been coming back to banks as deposits and have not been used. Moreover, such infrastructure projects have been concentrated in railways and rural/inland construction, which is much needed in China. This spending is unlikely to generate overcapacity and should enhance the medium-term efficiency of the economy and pave the way for the next economic upturn.
In addition, we believe the credit risk in China’s property market is well contained. Loans to the household sector picked up notably this year, largely reflecting the increase of mortgage loans, given the continued recovery in property transaction volumes since late last year. This round of property market revival was mostly driven by pent-up demand by first-time home buyers, given the notable improvement in housing affordability, amid the significant fall in housing prices, solid household income growth and government’s favorable policies. While the expectation for further price increase has started to attract speculators recently, commercial banks in areas where prices surged the most have re-applied stricter mortgage standards for second-home buyers and such strict standards have never been relaxed at the national/central government level.
After the surge in the first half, loan growth will naturally slow in the second, as most of the loans to large infrastructure projects were probably made in 1H. Meanwhile, the rising market interest rate and hence the higher bill discounting rate has tempered the bill-financing activities. On the other hand, loan demand from the private housing investment and SME will likely remain solid.
Liquidity not to deteriorate despite central bank fine-tuning
Given the surprisingly strong loan growth and economy, rising inflation expectation and the rebound in domestic asset prices, policymakers have started to fine-tune its highly accommodative policy stance, with the central bank resuming its 1-year PBoC bill issuance, targeted central bank bills and window guidance to curb excess credit expansion. Market interest rates have continued to climb recently despite flushed liquidity in the banking system, reflecting fears of further aggressive policy tightening. We believe the central bank could increase scrutiny of new bank loans and intensify its open market operation to restrain liquidity in 2H09. However, this does not mean liquidity in the banking system/economy would actually deteriorate. In particular, given the large size of PBoC bill and repo redemption in coming months, the magnitude of central bank’s net sterilization could still be modest, especially when compared to the fast fx reserve accumulation on the back of renewed capital inflows. Overall, we believe policymakers are unlikely to significantly alter their accommodative stance so long as the export engine is still sputtering and inflation pressures remained subdued. As such, we believe the policy normalization/tightening process is unlikely to start until at least next year, depending on the inflation and growth dynamics.
We estimate that PBoC bill and repo redemption will total more than RMB2.7tn in 2H09, largely concentrated in 3Q09. As a result, central bank may rely more on its open market operation to manage liquidity in the banking system in coming months.
Meanwhile, there seems to be renewed capital inflows. China’s official forex reserves rose to $2.132 trillion at the end of June. This represents a jump of $177.9bn in 2Q09, following the modest $7.7bn increase in 1Q09. The monthly fx accumulation pace of $59.3bn is significantly higher than the average monthly sum of the trade surplus and FDI inflows at $18.5bn last quarter. While part of this is likely owing to the increase in asset values other than USTR and fx revaluation gains on non-USD assets, capital inflows could have also picked up again on the back of renewed expectations of CNY appreciation as the economy recovers. Indeed, foreign currency loans at all financial institutions rose 8.1%oya in June, after falling 5.0% in May, while foreign currency deposit growth eased from May’s 18.2%oya to 16.0% in June. This likely reflects depositors’ inclinations to reduce foreign currency holdings, while borrowers are keen to increase foreign currency debt exposure, when there is expectation of CNY appreciation.