Credit Boom or Bust – Is the Great Wall of credit built on sand?

Tony McCormack

Articles and stories in the financial press, and latterly the mainstream media, have started a debate on the issues facing the Chinese economy and its banking sector. Concerns have been raised over the credit boom, house price inflation, the Trust companies lending to riskier borrowers, and the relative lack of transparency into the level of credit in China.

After the 2008 crisis, the Chinese government told banks to open for business. This was to provide credit for large-scale projects to offset unemployment caused by a global slow down and a drop in exports from China. At last count the level of credit is estimated at over $20 trillion – twice China’s GDP. This lending has come from both official banks and Trust companies.

Chinese currency reforms are on the way – but when?

The Chinese Government has pledged to open up their capital markets and internationalize the Chinese Renminbi which is strictly controlled by the Peoples Bank of China (PBOC). With the exception of the Shanghai Free Trade Pilot zone, the daily reference rate is set by the central bank. Rates are not allowed to vary by more than 1% from these fixings.

With the Renminbi down 0.9% last week and 1.4% on the month, the question is why the PBOC is driving rates lower? Could this be a sign of a long awaited relaxation of currency controls?

Economic freedom but political inertia?

The Chinese government has a social contract with the Chinese people – continue to create material wealth and the people will not ask for political change. In theory when the markets are going up this relationship is balanced. But should the economy falter and the property bubble burst then that relationship would be broken. People will be left with less money (e.g. investment properties in negative equity) and still have the bills to pay.

If the government reneges on their promises then the Chinese people will almost certainly demand a say in the political process. To be denied this will be doubly frustrating for the population as they continue to see party officials making large amounts of money from corruption.

Striving for 7.5% - will the mini stimulus be enough to drive growth?

What are the immediate prospects for the Chinese economy? The Chinese government has clearly stated that it expects the economy to grow by 7.5% in 2014. In order to achieve this goal, it is planning a mini-stimulus package in rail financing to augment the construction stimulus already in place. Some tax breaks for small businesses are also on the agenda.

However there is an expectation that the economy will fall short in Q1. In a recent survey of analysts polled by Reuters, the consensus was to revise down Q1 GDP forecasts from 7.7% to 7.3%. Many economists doubt whether the mini-stimulus will in itself be sufficient to stop the economy losing further impetus in Q2, and are expecting the authorities to ease monetary policy too. "The measures will do some help but probably not enough. We think there may be monetary easing," said a senior economist at Daiwa Capital Markets in Hong Kong.

Tony McCormack

Tony is a content strategy and product management specialist with over 20 years experience in marketing and product management in Capital Markets. Tony is a Senior Consultant at BPM Works. His career includes senior marketing and product roles at Thomson Reuters, Thomson Financial, FTSE and Reuters.