China: Lower credit and GDP growth loom from Central bank’s deliberate credit squeeze

> Event: Over the past weeks, the Chinese financial system has been hit by a credit crunch due to the Popular Bank of China’s (PBoC) abrupt tightening of liquidity which led to record short-term interbank rates before those latter decreased albeit remaining at high levels.

After days of financial turmoil, the PBoC eased investors’ credit crunch fears by committing to support banks which lack liquidity and comply with official financial regulations. Nonetheless, the liquidity tightening persists despite Central Bank’s latest capital injections in the system.

> Impact on country risk: Two lessons can be drawn from the latest (voluntary) credit crunch. Firstly, financial instability risks posed by excessive credit growth exacerbated by the explosion of shadow banking – particularly in 2013 – are severe enough to decide the PBoC to cause liquidity shortage and fuel rare instability on China’s financial markets.

Beijing’s strict behaviour vis-à-vis banks can be explained by failed past measures to rein in less regulated and informal credit supply – often with speculative aims – thereby concluding that hard action had become necessary to compel banks to change lending practices, better manage liquidity risks and re-orientate their loans towards more productive projects.

Less available liquidity is expected in the coming months and hopefully a slowdown in shadow banking too. Secondly, Beijing seems unusually determined to tackle excessive credit expansion and rise banks’ vulnerabilities to the detriment of economic growth (at least under the condition that GDP growth remains close to the official 7.5% annual target).

This policy change, which further confirms that China has entered an economic transition period, is a welcome attempt to curtail excessive credit (whose total is estimated at beyond 200% of the GDP) and favour a more sustainable economic model.

However, given that credit has so far this year been an important growth driver of China’s weakened economy, less credit should translate into lower future GDP growth and negatively spill over to the external world (notably lower global commodity demand and prices).

A full-blown domestic banking crisis seems nevertheless unlikely given Beijing’s huge financial assets, giant foreign exchange reserves and central power capable of intervening on a still largely controlled banking sector.

analyst: Raphaël Cecchi, ONDD –

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