Despite Beijing’s pledge to ease monetary policy further, financial markets are sceptical about how effective this would be in boosting economic growth. One notable concern is the growing gap between M1 narrow money and M2 broad money growth, which suggests that economic agents would rather save than spend.
We believe a recovery in credit growth holds the key to the outlook for economic growth and asset markets. In turn, and somewhat ironically, reducing debt holds the key to the recovery of credit growth.
A glass half full
On a positive note, China’s credit impulse (the ratio of new credit to GDP flows) has started to improve recently (see Exhibit 1). The recent narrowing of the M1-M2 growth gap echoes this recovery. From a policy perspective, it is likely that the end of a multi-year crackdown on shadow banking in the wealth management product (WMP) sector will help further propel the recovery of the credit cycle.
In 2018, Chinese regulators imposed sweeping rules to rein in commercial banks’ WMPs as part of a wider deleveraging campaign to reduce systemic risk.1 At the time, banks were given three years to meet regulatory standards. These included:
- Removing implicit guarantees against WMP investment losses
- Standardising the management of the banks’ fund pools
- Divesting in non-standard (i.e., high risk) debt instruments which were mainly shadow banking assets.
These rules led to a sharp decline in commercial banks’ WMP products, which caused a massive drop in shadow bank financing (see Exhibit 2). This financial reform strengthened regulatory oversight of China’s wealth management business and helped to reduce systemic risk. However, it also amplified the credit crunch on the economy in recent years as shadow bank credit accounts for 30% of total credit.
The WMP overhaul ended in 2021 when regulators were satisfied with the clean-up of non-compliant assets. While the authorities will not tolerate another boom in risky WMPs, the worst of the crackdown on the shadow banking sector is behind us.
This should allow overall credit growth to improve. Furthermore, after the overhaul, the People’s Bank of China will likely be more comfortable with easing monetary policy without having to be overly concerned about misallocating liquidity to dubious lending channels.
Furthermore, the pace of China’s reform of initial public offerings (IPOs) has quickened. This could help the corporate sector to raise capital in the markets and reduce the system’s reliance on debt financing.
Regulators have announced plans to expand the registration-based IPO system. This is currently being tried out in China’s smaller venture boards and may be extended to the main boards this year.
These much-needed IPO reforms should enhance market forces in pricing IPOs and help improve the efficiency of China’s capital markets. In the short term, it also promotes equity financing which is already part of the system’s aggregate financing.
The bottom line
China’s credit cycle has bottomed out. It looks set to continue to recover as shadow bank credit and equity financing – two components of aggregate financing that account for more than one-third of the total – are increasing.
China has persevered with its debt-reduction resolve, even in tough times, as we have argued.2 By maintaining the financial de-risking policy between 2018 and 2021, despite the trade war with the US and the Covid-19 health crisis, the debt reduction campaign is gradually helping to unclog the credit logjam.
Recent evidence shows that persisting with deleveraging – both by retreating from implicit guarantees and tolerating defaults and bankruptcies – has delivered results.
Notably, state-owned China Huarong Asset Management Company, which has been restructuring since failing to publish its annual financial results, recently announced profits of RMB 370 million (USD 58.4 million) last year, marking a major turnaround from its 2020 loss of RMB 102.9 billion.3
For us, this indicates that one should not exaggerate any concerns over China’s debt risk.4
1 See “Chi on China: China’s Deleveraging Strategy and Evidence”, 22 November 2017
2 See “Chi on China: When Structural Objectives Clash with Cyclical Forces”, 7 January 2022
3 “China Hurong Asset Management Swung to Profit in 2021”, MarketWatch, 20 March 2022. Retrieved from https://www.marketwatch.com/story/china-huarong-asset-management-swung-to-profit-in-2021-271647819906
4 See “Chi on China: China’s Debt Vulnerability (V) – Defying Dire Predictions”, 4 February 2022