The Chinese economy is one of the two giant economies in the global market. We have got used to relying on China to produce growth of more than 6%, and to supply a wide range of manufactured items at attractive prices. The combined effects of a huge expansion of Chinese manufacturing capacity, and the digital revolution in the west to import and sell Chinese products on to western consumers has been an important part of the recovery from the 2008-9 US and European crash.
China has spent this year striving to tidy up her banking sector. Heady Chinese growth was propelled by plenty of credit. To escape the formal controls on the main banks, a large shadow banking sector sprang into life. A range of products from entrusted loans, through Trust loans to so called asset management and wealth management products were used by non-banks, and indirectly by the banks themselves to offer people better deposit rates and investment returns. The money collected from customers was used to make a wide range of loans to Chinese commerce and society. Some of these loans were risky, as financial businesses competed to provide a better promised return by taking on more risk.
At its peak it is estimated that the shadow arrangements reached $10 trillion of assets and liabilities. The fear of the pessimists is that this conceals a large number of bad debts and non-performing loans, which gradually have to be revealed, written off or renegotiated. Chinese regulators occasionally make a bank or financial institution change its appraisal of its assets and recognise more of the damage done by taking on too much risk. So far, the Chinese authorities have done this at a measured pace, not wishing to bring the whole system into difficulty by identifying too much bad debt or spooking markets by giving credence to worries that the system is precarious. This prudent approach is welcome, but it does not prevent the actions they are taking being a brake on growth and future activity.
China is more at risk than the USA from the tariffs the USA is imposing
This year there has been a distinct slowing in the rate of Chinese money growth as a result of this greater caution. The authorities, conscious of the dangers of too sharp a slowdown in credit and liquidity, have been taking some offsetting action. The reserve ratio they require the larger banks to maintain has been cut to 14.5%, meaning the banks can now lend more for the same sized balance sheet. More of their deposits from customers can now be lent on, with this new lower ratio. The latest reduction, from 15.5% to 14.5% is thought to allow around $100bn of extra money to find its way into the economy. Despite successive cuts in the ratio, so far there has been a slowdown. The Central Bank claims its policy is neutral. They claim their policy is fully compliant with President Xi’s political theory “thoughts on socialism with Chinese characteristics for a New Era”.
In its latest Monetary Policy Report, the Bank provides more detail. It acknowledges that domestic demand is becoming a more important driver of economic growth, where once exports and investment led the way. The Bank tells us that: “The real economy and financial sector both have made good progress in structural adjustments, yet deep seated and critical contradictions still persist”. The authors seem to accept that the tasks of reducing industrial overcapacity, empowering consumers to buy more, and getting a better balance into the economy, is difficult at the same time as reining in credit. They also remind us that the “international economy and financial situation has become more complex” which is a delicate way of skirting the impact of trade warrior Mr Trump.
The Chinese Central Bank assures us they “keep liquidity at a reasonably ample level” within the context of their neutral policy. So far the policy has proved to be one of unintended tightening, as they struggle with their “contradictions”. China is more at risk than the USA from the tariffs the USA is imposing, given the large imbalance in trade between them. We assume China will muddle through, but the task has got more arduous with the trade war complicating industrial adjustment. The authorities are clearly finding it difficult to judge the pace of adjustment for the financial sector. If they want that tidied up too quickly it could slow things down too dramatically. We are watching it all carefully, but do not yet see a trade or banking resolution in sight that would make stock markets more positive about the transitions underway.
The above article was previously published by Charles Stanley on 9th October 2018