China at economic and financial crossroads
Reforms dive deep into turbulent waters
China’s financial system may hinder reform policies and economic growth. Banks may be piling up huge loads of bad debt. A credit squeeze is the government response to bad banking practices, but that policy may hamper more all the drivers of Chinese economic growth. June’s Chinese trade data are disappointing and the surge of the yuan against the yen and the US dollar is not helping.
These last months, China’s hidden banking system has been coming out of the shadows as the government seeks to rein in the excessive lending that fears could spin out of control. The People’s Bank of China, the central bank, let the world know that it was putting the nation’s banks on notice: the loose money and the speculation it fed must stop. It said banks had to step up risk controls and improve cash management, avoiding a “stampede” mentality.
The PBoC precipitated a cash squeeze among the banks that sent their short-term interest rates sharply higher. The crackdown, which appears aimed at reining in banks engaged in complex deals that involve hiding and repackaging risky loans, so that regulators cannot notice them led to a sharp sell-off in stocks worldwide during the last week. Investors feared it might further slow the Chinese economy. However, its financial and banking system remains opaque to Chinese and foreigners alike. The full toll of the liquidity squeeze that hit China in June has yet to flow through the real economy. According to a Bloomberg News survey of economists, that squeeze “is likely to reduce credit growth this year by 750 billion yuan (about $121 billion).”
“The government knows some banks are doing things that aren’t prudent,” says Yukon Huang, a senior associate at the Carnegie Endowment for International Peace in Washington. “Some of them are taking easy money and putting it in Ponzi schemes. The government is saying, ‘Don’t do that anymore. And don’t count on the government to bail you out.’ ”
Li Keqiang, China’s prime minister, who took office last March, has promised a more market-oriented approach to managing the economy. There are interest groups that sometimes resist pressure from the center or turn to allies in the central leadership who block such moves. The government’s target is the sharp and potentially dangerous rise in the so-called shadow banking. Banks borrow at the low interbank rate, then lend to trust companies and smaller banks, which in turn make riskier loans. There are mounting concerns here that the good times could be over partly because the banking sector is hiding piles of bad debt.
The Chinese government has the policy tools to deal with a crisis that includes huge foreign exchange reserves and the ability to force state banks to lend in a time of crisis. Banks lent a huge amount of money in the first half of this year, and yet growth has been tepid. Manufacturing has begun to contract, according to a recent survey, and banks seem desperate for more cash. Worldwide influential analysts are now revising their economic growth forecasts downward and warning that the Chinese central bank’s refusal to alleviate commercial banks’ cash shortages by pumping more money into the economy could lead some smaller banks to default. They warn of other dangers facing China’s economic policy makers. If the property market stumbles, some analysts fear that could wallop the broader economy.
China’s exports had been buoyant early in the year, according to official statistics. Albeit some analysts have questioned whether trade speculators, pretending to sell goods overseas in order to bring money into the country they would then use to speculate in the financial markets, were manipulating statistics. The most recent export figures have been less robust, possibly hurt by China’s currency, the renminbi or yuan, which has strengthened over the last year against the dollar and the Japanese yen.
The prime minister and his economic team are trying to move swiftly to guard against a crisis down the road, after years of loose credit and heavy spending on manufacturing, property and infrastructure. Although, if they press too hard, analysts say, an already weakening economy could lock up, and see growth dip below 7 percent, starting even more trouble with the banking sector.
The combination of slower economic expansion and the liquidity squeeze offers one of the biggest challenges yet to the newly installed leadership in Beijing. China’s economy has been showing signs of a slowdown in recent months. Economists at HSBC, a leading global bank, joined counterparts at several other banks on in cutting growth forecasts for the Chinese economy this year. The preliminary purchasing managers’ index, published by HSBC and compiled by Markit, dropped to 48.3 points in the first three weeks of June, its lowest level since September and down from a final figure of 49.2 in May. A reading above 50 indicates growth, and anything below signals contraction. “Beijing prefers to use reforms rather than stimulus to sustain growth,” said Qu Hongbin, HSBC’s chief economist for China, in a statement accompanying the survey results. “While reforms can boost long-term growth, they will have a limited impact in the short term.”
The June trade data, released some days ago, were a huge disappointment as both imports and exports unexpectedly fell year over year. The decline in monthly exports was the first in a non-holiday month since the financial crisis. Several economists wrote on that the weak that trade data could spur Beijing to devalue the renminbi, a move that would be problematic for United States-China relations, and for China‘s trade partners worldwide.
“Macro controls should keep the economy’s performance in a reasonable range, keep the growth rate and employment level from falling under a floor and keep inflation from rising above an upper bound,” Premier Li Keqiang said recently. Barclays Capital, a branch of another leading global bank, recently coined the term “Likonomics” to describe the policies of Premier Li. The three pillars, according to Barclays, are “no stimulus, deleveraging and structural reform.”
Transparency is not strength of the Chinese government, so while there are signs that bigger things are going on it is difficult to be certain. Regardless, the long, hot summer is just getting started and the economy has more weakness ahead.