China: Credit Tightening, with Backdoor Support

Published on May 10, 2017

A tightening regulatory and central bank policy environment has led to a new round of jitters in local Chinese equity markets.

But we expect this current episode to be markedly different from the experience of the summer of 2015, when similar Chinese efforts to tighten credit in the face then of a still very tentative global and domestic recovery turned into a downdraft and a global collapse in equity and commodity markets around the world – one that was severe enough at the time to stay the Federal Reserve’s hand in hiking US interest rates.

*** It is materially different because this time around, credit tightening measures are being implemented only with the full knowledge and confidence by the top leadership in Beijing that Chinese economic growth has largely bottomed, and is on a relatively firm footing (6.8% GDP growth expected for Q2 2017, 6.7% for H2 2017). The economy can now easily withstand some modest credit and monetary tightening measures, in parallel with a much more pronounced US rate hike cycle, including at least two more hikes this year, and that resilience in the Chinese economy is expected to be confirmed in the upcoming data releases for April. ***

*** It is also different because, for all the public efforts at reining in loose credit, Beijing has been embarking on a quiet but solid dose of central government and local fiscal stimulus injections at the same time as tightening monetary policy as well. And from what we understand, Chinese officials expect that fiscal spending to go up in the second half of the year, once the Central Financial Leading Group reviews fiscal revenue and expenditure targets in late July. ***

*** And while commodity prices have fallen along with Chinese markets, this should be no redux of the ferocious collapse in commodity markets that followed the last credit tightening by Beijing in 2015, at least not in the oil markets. Not only are fears of current credit tightening policies leading to slower demand growth vastly overblown, but Beijing is actively coordinating with Russia and Saudi Arabia to step in as a buyer of last resort and replenish its strategic reserves if oil were to continue to drop. Chinese officials believe a stable oil market in the $50 – 55 plus range, as targeted by OPEC and non-OPEC producers, is in China’s interests as well (see SGH 5/5/17, “Oil: A Strategic Underpinning to Higher Prices”). ***

Growth with Spending, Just in Case

Beijing’s expectations are that even with some new, high profile, credit tightening measures, GDP growth in H2 of 2017 is likely to come in at least at 6.7%, and China’s economic leadership is confident that China’s economy can withstand two more Federal Reserve rate hikes this year.

That message was conveyed in no uncertain terms by PBoC Governor Zhou Xiaochuan and Finance Minister Xiao Jie to a US delegation at the IMF Spring Meetings less than a month ago that included everyone that mattered – Fed Chair Janet Yellen, Vice-Chairman Stanley Fischer, NEC Director Gary Cohn, and Treasury Secretary Steve Mnuchin – everyone that is except perhaps Ivanka and Jared (see SGH 4/26/17; “China: FX, Rate Hikes, and Credit – Postscript from IMF Meetings”).

But while the Chinese government is taking efforts to control debt and financial risks, Beijing has also upped its spending, as well as that of local governments, and is eyeing fiscal expansion for the remainder of the year. The central government will lean on local governments to increase spending in the public sector over the next three quarters, even as they are asked to tightly control debt risk.

For evidence of this “proactive fiscal policy,” officials point to double-digit spending growth over the first four months of April. Government spending – when including central and local governments – expanded at nearly a whopping 30% year-on-year pace over the last two months, March and April, well above the same period last year’s 12.3% pace.

And to ensure stable economic growth even while achieving supply side structural reform and better controlling economic risk, from what we understand Chinese officials will push to increase the target for government spending in the second half of the year even higher when the Central Financial Leading Group reviews fiscal revenue and fiscal expenditures in late July, and fully expect those measures to be adopted.

With a Backdrop of Decent Data

Even with additional spending, the credit tightening measures are certain to create an economic pinch. The National Development and Reform Commission (NDRC) is nevertheless still forecasting solid data, including as recently as at a briefing with the State Council and Politburo’s Central Finance Leading Group that was held last Friday, on May 5.

The NDRC expected PMI and industrial added value data to come down, but investment and exports were seen to have kept on a steady growth path last month. And the NDRC expected other growth data to come in a tad higher than market expectations.

The NDRC presented a forecast of 1.1% YoY for April CPI and 7.0% for PPI (the actual data came in last night even higher on CPI, at 1.2%, but lower on PPI, at 6.4%). For growth data, the NDRC forecast 7.6% for April Industrial Production, which is down about 0.5% from March, but that happened to be at a 27-month high; and forecast Fixed Asset Investment growth of 9.6% for the first four months of the year due to a rebound in private investment and manufacturing, which is 0.4% higher than it was for the first three months of the year.

April Retail Sales data is expected to taper off a bit from March’s 10.9% pace, but it should still hold strong at a 10.6% YoY pace, and maintain a steady pace through the year.

All in all, the NDRC sees the April data as providing a solid foundation for deepening supply-side structural reform, strengthening financial risk control, and controlling the real estate boom in first and second-tier cities. If the current trend were to continue through the next two months, second quarter GDP should come in at a healthy 6.8% YoY pace.

A Serious Effort at Risk Management

That is not to say that efforts to rein in China’s financial risks, led by President Xi Jinping himself, are not for real. It’s just that the backdrop for taking such measures is relatively solid.

In case there was any doubt, to underscore the emphasis on financial risk, Xi and Premier Li Keqiang invited PBoC Governor Zhou, Finance Minister Xiao, and senior officials from the China Securities Regulatory Commission (CSRC), China Banking Regulatory Commission (CBRC), and China Insurance Regulatory Commission (CIRC) to a group study attended by Politburo members in Zhongnanhai on the afternoon of April 27.

Xi stated that the stabilizing economy has created more room for financial regulators to take actions to strengthen risk prevention and intensify supervision of financial risks. All levels of government were told to avoid “massive short-term” stimulus, stick to prudent and neutral monetary policy, and rationalize fiscal responsibilities.

Xi also promised that if regulatory measures from the three agencies were to achieve the desired results before the 19th CPC National Conference, they would be allowed to retain their current formats during the government reorganization that is scheduled for May 2018. Otherwise, he warned, the three agencies could be rolled into one, or parts of them subsumed into the central bank, the PBoC.

As to specific policy guidelines, Premier Li directed the PBoC to tighten funds in the banking system, the CBRC to pay notice to non-performing and real estate related loans (real estate accounted for more than a third of total loans last year), the MOF to correct irregular fundraising behavior among local governments, the CSRC to stop risky behavior in stock markets and apply zero tolerance to insider trading, and the CIRC to tighten its grip on insurers.

Chinese officials concede the tightening of regulatory conditions has put pressure on money markets recently, and fully expect the new measures to contribute to some nervousness in markets and exert some pressure on growth. That is both reasonable and normal.

But with a healthy overall macro backdrop, both domestically and worldwide, that nervousness should be temporary. It is a narrative that we think is not so hard to understand.

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