Posted by on October 18, 2016 10:13 pm
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Categories: Australia Bank Run Barclays Bond Borrowing Costs China Economy Evans-Pritchard Hong Kong International Monetary Fund Janet Yellen M1 M2 Money Supply Mortgage Loans New Zealand Nominal GDP Rating Agencies Real estate Reality Renminbi Shadow Banking Yuan

Overnight the PBOC reported its debt statistics for the month of September and it will probably not come as a surprise that for yet another month, China flooded its economy with the latest massive new loan injection, while the country’s broadest aggregate measure of new credit, Total Social Financing, again surpassed estimates with the number exceeding a quarter trillion dollars in total new debt, in order to fuel, what Bloomberg dubbed, “the economy’s continued stabilization”, even though the economy is inherently unstable due to the massive stock of debt already present inside China’s financial system.

To summarize, this is what China’s credit creation looked like in September:

  • Aggregate financing was 1.72 trillion yuan, or $255 billion, higher than the median estimate of 1.39 trillion Yuan
  • New yuan loans stood at 1.22 trillion yuan, higher than the median estimate of 1 trillion Yuan
    • Of this, new home mortgage loans rose 205.5b yuan from year ago, Shanghai Securities News reported
    • New home mortgage loans in first three quarters at 3.63t yuan, making up 35.7% of total new loans

Visually, the ongoing surge in TSF is shown below:

The table below shows TSF broken down by component. The notable changes, aside from the surge in plain vanilla Yuan loans, was the latest decline in FX loans, which some suggest is how a modest amount of capital is used to exit the country, as well as the CNY 220 billion slump in Bankers acceptances, which together with entrusted loans, comprise the core funding conduits of China’s shadow banking system.

Also notable is that the broad M2 money supply rose 11.5% from a year earlier, fractionally below the 11.6% estimate but higher than the 11.4% in August, a pace that remains nearly double that of the country’s GDP, which suggests that it takes roughly 2 Yuan in new debt to generate 1 Renminbi in GDP. Meanwhile M1 has stopped growing.

Putting this ongoing debt binge – which as on previous occasions has succeeded in stabilizing the economy, however left it with even less breathing space for the next time the economy needs a debt-funded push – in context, policy makers are switching focus to reining in soaring home price gains that cheap borrowing costs have spurred. As Bloomberg notes, China urgently needs a plan to address a build up of corporate debt that’s manageable but with a window to address it “closing quickly,” according to an International Monetary Fund working paper. As the September data reveals, the only solution Beijing has to the debt problem, is to provide even more of it.

Below are some of the dazed and confused economist takeaways from last night’s data:

  • The government is in a dilemma: if they tighten the real estate sector too much, the economy could turn down sharply; but if they don’t control it, they’ll allow the bubble to expand,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. He expects a sharp slowdown in credit expansion in October.
  • It’s more of the same: more yuan lending, more debt, no real increase in M2 growth and a much larger rise in M1 growth,” said Michael Every, head of financial markets research at Rabobank in Hong Kong. “It screams ’Liquidity trap!”
  • “The property frenzy will certainly limit the PBOC’s appetite for further easing,” said Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong. “While it is too early to call for tightening, deleveraging is certainly an ongoing theme” in the fourth quarter.
  • “While credit growth remains rapid relative to a couple of years ago, it has been slowing in recent months,” Julian Evans-Pritchard, economist at Capital Economics in Singapore, wrote in an e-mail. “Broader worries about credit risks means further monetary easing is unlikely. It will take time for this more cautious policy stance to impact economic growth.”
  • “Beijing talks about controlling credit but allows the banks to increase loans,” said Andrew Collier, an independent analyst in Hong Kong and former president of Bank of China International USA. “The official message is not the same as the reality. Pressure from the banks for profits, from corporates for loans, and from local governments for revenue from the property sector is driving the Chinese economic bus more than the policy makers in Beijing.”

* * *

Incidentally, the real picture is even worse than shown above.

A quick background on Total Social Financing (TSF), courtesy of Barclays:

In early 2011, the PBoC launched a new data series, total social financing (TSF), as a comprehensive indicator to monitor the economy’s total fundraising. Its development was in response to the rapidly growing shadow banking and direct financing amid increasing financial disintermediation and regulatory arbitrage. As a result of these changes in China’s financial landscape, it was thought that traditional indicators such as bank loans or deposits no longer captured the full picture of financing/investment and money supply/demand.

Over time, TSF developed into a macro control tool, together with broad money (M2). “To maintain a reasonable growth in the money credit and TSF” is now a phrase written in the annual government work report since 2011. In March 2016, the government for the first time set an explicit target for TSF growth of 13%, slightly higher than actual growth of 12.4% in 2015, in addition to its 13% M2 growth target (up from a target of 12% in 2015).

Defined by the PBoC to measure the domestic financial sector’s (non-government) support to the real economy, the TSF statistics include bank loans, corporate bonds, three traditional shadow banking activities, as well as equity financing since its release in 2011(Appendix). The shadow credit includes loans by trust companies, inter-corporate entrusted loans, and undiscounted bankers’ acceptance bills. The TSF by design excluded: 1) government bonds, but has included the local government financing vehicle (LGFV) loans and bonds; and 2) external debt, such as foreign direct investment and other foreign borrowings.

However, as we showed previously even TSF is not sufficient to capture all the nuances of China’s debt. Two core credit items the TSF is missing are Government bonds, both central government and local government, and “Non-traditional shadow credit channelled by banks and NBFIs.” To be sure, there is much more to Chinese credit creation, much of it in the “shadow banking sector” as the following graphic shows:

… but if one adds just those two inclusions, the result is a far greater annual increase in the broadest credit aggregate which includes TSF, Government Bonds, LG bonds, and Bank claims on NBFIs (shadow banking), one gets the light blue line shown below.

What happens if one uses these adjusted credit aggregates instead of the widely accepted TSF? Here are some thoughts from Barclays:

From a stock perspective, broad credit is 20-30% higher than what is counted in the official TSF data. Relative to GDP, our five measures put China’s credit-to-GDP ratio currently in a range from 260% to 275% of GDP as of September 2016.

From a growth rate perspective, the speed of credit expansion is alarming. Our methods put the current pace of credit growth in China in a range between 19% and 20%, well above the reported official TSF growth of 12.4% and new loan growth of 13.0% in September.

Using a bottom-up approach, we made ballpark estimations of the size of “shadow credit” based on the above discussions, which reached around CNY63trn as of September 2016. This is calculated by adding the ultimate forms of credit, ie, trust loans (September: CNY5.9trn), entrusted loans (CNY12.5trn), bankers’ acceptances (CNY3.8trn), corporate bonds (CNY17.3trn), and other non-standard credit assets5 (CNY23.5trn).

Frankly, these are mindblowing numbers and yet, Barclays does not think China’s debt bubble is about to burst despite admitting that this pace of debt growth is unsustainable.

As the bank admits, “China’s debt crisis does not appear to be imminent. China’s debt is largely domestically owned. Hence, unless there is bank run or capital flight by local residents, the typical EM-style financial crisis, like the Asia Financial Crisis, is less likely. The heavy state involvement, with the majority of loans coming from state-controlled banks to state-owned enterprises, the strengthening state control and sizable state assets suggest that the Chinese government still has the capacity to manage the pace of NPL recognition and debt restructuring in the banking system.”

But it’s not all good news: “On the other hand, the current pace of credit expansion, more than twice the rate of nominal GDP growth, is clearly unsustainable (Figure 13).” It then concludes as follows:

The interconnectedness between the corporate sector and the banks points to systemic risks in the economy, especially as the economy is forecast to slow further. Such perceived “implicit guarantees” by the state have resulted in excessive risk-taking across asset classes (equity, bond and property), across economic agents (corporate, local governments and households), and across financial intermediaries. With rising central government’s contingent liability, the sovereign risks are increasing. Moody’s downgraded its outlook on Chinese government debt to negative from stable in March 2016, questioning China’s surging debt burden and the government’s ability to enact reforms.”

So far the only “reform” the government has enacted has been to mask debt with even more debt, roughly 300% of GDP. However, as banks, rating agencies, the IMF and even the G-20 admit, the days of kicking the can for China are coming to an end. What waits on the other side of that particular journey is not pleasant: either massive social revolt by China’s middle class, as the government renormalizes its economy in the process hiring tens of million of (soon to be angry) workers, or it unleashes the biggest banking crisis the world has every seen: at $35 trillion in total financial assets, China’s banking system is more than double the size of the US. We wish Beijing (and Janet Yellen) the best of luck with their hopes that it will somehow be contained…

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