China’s credit growth – Could it be a destabilising factor to economic growth if left unchecked?

The topic of China’s credit growth has been widely discussed, and whether the size of the credit ‘bubble’ is out of control given the various measures undertaken by the Central Government in Beijing to curb such excesses in credit availability. In a Bloomberg Television interview during Asian morning hours on June 18, 2013, the head of Fitch Ratings, Ms. Charlene Chu was interviewed on the programme, ‘First Up’ by Zeb Eckert. During the interview, Ms. Chu gave her opinion on the state of credit growth in China in which she mentioned that although liquidity has been tightening, including the distribution of wealth management products, but the pace of credit growth has not been fully abated, and this led to banking sector problems which could either result in slow growth in China, or could potentially manifests itself into a banking crisis. According to a news article published on June 13, 2013, it was reported that in the latest China’s National Audit Office review, and compiled by Moody’s, it revealed that total government debt and guaranteed debt may have risen 13.0 percent to 12.1 trillion Chinese Yuan (USD 2.0 trillion) by end 2012 from end-2010. This is based on the credit ratings agency’s own calculations through using data in the report which showed an approximately 13.0 percent increase in the debts of a sample of 36 local authorities.

The various credit issues emerging in China have been the result of the rapid rise of China’s economic growth through local public infrastructure spending, and real estate boom taking place in many Chinese cities. The issue is also been exacerbated by the emergence of the so-called ‘shadow’ banking system where there are many small non-bank financial institutions dispensing credit, and do not fall under the regulatory oversight of many Chinese financial regulators. The ‘shadow’ banking system has resulted in the lack of transparency as it relates to the quality of the borrowing, lending, and as well as the assets. In addition, as Ms. Chu pointed out, most of the lending that has taken place in China has been to the distressed small-and-medium sized enterprises (SMEs), and/or property developers, who are in need of debt financing in order to finance their expansion plans or construction activities in the case of the property developers.

Fitch Ratings Ltd. has for the past month came out to downgrade China’s long-term currency to ‘AA-‘, and its long-term debt was reduced to a ‘A’ rating. The credit ratings agency maintained its local and foreign sovereign ratings as ‘Stable’. However, this revised credit rating does not absolve the core issue of massive credit growth that is still taking place despite measures being put in place, and how the financial regulators are able to monitor the growth, that if left unchecked, could spiral towards a banking crisis, which might also cause massive meltdowns that will threaten the world’s economic growth going forward.

In a June 10, 2013 official report released by China’s National Audit Office, it was reported that debts of local governments chosen for scrutiny increased to approximately 3.9 trillion Chinese Yuan in two years through December 31, 2012. Those 36 regions, as indicated in that Moody’s report cited earlier in the paragraph, accounted for approximately 32.0 percent of total government debt as of end 2010. In the report, it was cited that nine provincial capital cities had debt ratios exceeding 100.0 percent, excluding 2012’s growth which stood at approximately 189.0 percent. This rapid rise was described in the auditor’s report as “protrusive” debt risks. Some cities cited in the report was reportedly rolling over its debts, with five repaying more than 20.0 percent of debt in 2012 with new borrowings.

The rapid rise in credit growth is quite destabilising when viewed by investors, particularly when in a June 14, 2013 Bloomberg report which indicated that China did not manage to generate enough demand for its debt, and it resulted in the local banks operating throughout the country facing a credit crunch. The seven day repurchase rate (Repo), a gauge of interbank funding availability, averaged approximately 6.03 percent, which was a historical high since the National Interbank Funding Centre began compiling a weighted average in 2006. This resulted in one of China’s largest State-Owned (SOE) financial institutions, Agricultural Development Bank of China Co. scaling back the size of two bond offerings on June 18, 2013 by approximately 31.0 percent citing liquidity crunch squeezing demand for the securities.

The rise in credit growth has shown to be one of the potential destabilising factors that could easily tip China into a long-term recessionary path. If these various banking issues are not fully resolved, it could lead to severe repercussions. The Chinese banking authorities, together with the Central Government ought to pay close attention on the potential excesses, and issues that are caused by the high levels and availability of credit. There ought to be tight measures implemented that guard against indiscriminate lending, especially to the real estate sector where we have seen the number of transactions have not declined significantly despite the many measures imposed by both the Central Government and the provincial governments to crackdown on indiscriminate lending. The ‘shadow’ banking system ought to include tighter financial disclosure requirements in order to bring about transparency, and accountability. However, despite many years of controlling the direction of the Chinese economy, the Chinese banking regulators have not fully tackled the issue, preferring to concentrate on generating economic growth, without making sure that structural and credit reforms needed to be implemented in order to bring about confidence and order to the entire financial system.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc