There were fears that a reduction in lending in the second half of 2009 would damage the Chinese economy. Yet, it looks like the stimulus and huge lending experienced in 1H09 might have been sufficient to buoy the Chinese economy after all. Just look at the following three metrics:
1. Industrial output in 8/09 was up 11.8% (annualized). That comes on the back of a 10.8% annualized increase in July.
2. Retail sales were up an annualized 15% in August
3. Alcoa (the largest aluminum producer in the US) has raised its 2H09e forecast of global consumption, citing the Chinese car market as a primary driver. They estimate that in 2009 China will overtake the US as the largest car market globally with 12m unit sales. Alcoa was up 3.45% (beating the S&P’s +0.88% performance).
All of this has been good news for the market – rising now for 6 consecutive days after dropping 20% in August.
Chinese banks received a draft ruling that would require them to deduct existing subordinated and hybrid debt sold by other lenders from supplementary capital. In addition, the new rules would limit the amount of hybrid and subordinated debt held by a single bank to 15% of core capital (and 20% for all banks in total).
The banks have been given until the 25 August to provide their feedback on the issue to the China Banking Regulatory Commission.
The upshot maybe to increase minimum capital adequacy ratios by reducing lending, or increasing capital by selling more shares to the market. In fact, the regulator has asked small banks to increase their CAR to 12% (from 10%).
Chinese stocks have stuttered as investors are concerned that such a move would curtail loan growth. A significant portion of Chinese growth has been driven by increased lending and stimulus spending, in an attempt to plug the export hole.
In my opinion the commission is correct in focusing on ‘main-street’ and crafting a path of more sustainable growth, ensuring that asset bubbles are contained, and non-performing loans are kept to a minimum. In this case the stock market should clearly play second fiddle.
Growth spurred by lending
Last week economists were busy increasing their 2009e China GDP forecasts to around the magic 8% figure. The hike in new credit during 1H09 was surely a major contributing factor. During the first half of the year Chinese banks lent a record Y7.37bn, 300% larger than 1H08, and 47% higher than the government’s full-year 2009 Y5bn target.
Walking the tight-rope
The government is walking a tight rope, and will have to manage the economy to prevent assets bubbles, bad loans, and inflation, whilst simultaneously accounting for potential deflation (currently a concern in the US), and damaging shocks to the flow of capital.
President Hu Jintao told the Politburo on Thursday that the recovery was still nascent, and as such China would maintain its “relatively loose” monetary policy and proactive fiscal policy. On Saturday the People’s Bank of China (PBOC) said it “would guide loans to grow appropriately” and “will aim at better allocation of credit in the real economy.
Mopping up liquidity: Y100bn of notes announced
The PBOC has announced the issue of Y100bn of one-year bills to prevent a surge in lending in 3Q (note: July is historically China’s slowest month for new loans). According to Caijing magazine the PBOC has ordered the Bank of China (the county’s third largest lender) to purchase Y45bn of the notes, after the bank lent more than any of its competitors during 1H09. The notes carry 1.5% interest rate (lower than the general 2.25 deposit rate).
Expectation: measured approach – reserve rates to rise
I expect the government and its organs to continue taking a measured and pinpointed approach to ensure growth and suppress bubbles. As well as the new notes, I see banks reserve rates increasing from their current 15.5% for larger lenders, and 13.5% for smaller banks. I see an increase in reserve rates most likely to wait until 2010, unless data for credit extended in July and the coming months exhibits any significant spikes.