Sunday, 15 February 2015

China's Continuing Credit Squeeze, Impact on Trade

China’s January monetary data has to be read with extra caution, since the available data can be read either as:
a) disclosing a significant loosening of policy, with M1 growth up 10.6% yoy (from 3.2% in Dec), and new bank lending of Rmb1,470bn, which was the highest since the credit splurge of early 2009, and up 11.4% yoy; or
b) showing not significant improvement in liquidity conditions, since M2 growth slowed to 10.8%  (from 12.2% in Dec), and new aggregate financing, (which as well as bank lending includes ‘shadow banking activities’, foreign lending, bond and equity market financing) came to a less-striking Rmb2,050bn, which was 21.2% less than in January 2014.

On balance, the dour conclusion is probably nearer the truth. The key development driving January’s seeming expansion of bank lending was PBOC’s late-December decision to broaden the definition of deposits which are counted in bank’s loan to deposit ratio, which is subject to a regulatory ceiling of 75%. Specifically, PBOC now includes in its definition of commercial banks’ deposits those savings held by banks for non-deposit-taking financial institutions – such as stockbrokers, for example. Not only are these savings now included in the deposits calculation but in addition,   for the time being banks are not compelled to hold reserve ratios against them.  This rule-change matters, since these types of savings accounted for approximately 8% of the total deposits of listed banks, and consequently, they allow and encourage a significant increase in bank lending. 

But there is a cost: if these deposits are used to fund commercial bank lending, they are not available to fund other forms of financing. Hence whilst January’s bank lending rose sharply, this was paid for by the virtual annihilation of entrusted loans and trust loans.  In December, Rmb 668bn of these were issued/created; in January that total collapsed to just Rmb86bn.  So whilst growth of bank lending accelerated to 14.3% yoy in January, with a monthly gain which was 1.5SDs above historic seasonal trends,  the stock of total aggregate financing, by my estimate at least, slowed to 13.3% yoy on a monthly movement which was 1.2SDs below historic seasonal trends. And that broader financial aggregate is the one which matters. 

The unrelieved financial stress on China’s industrial economy also shows up in January's trade data. The trade surplus hit a record US$60.1bn, but this reflected the dramatic weakness of imports (down 19.9% yoy), not any strength in exports, which fell 3.3% yoy and were 0.6SDs below historic seasonal trends. This is a record surplus born out of shocking weakness in import demand, not an export-machine grabbing market share, or even a terms of trade benefit granted by falling commodity prices. More policy stimulus is urgently needed  to bolster working capital and cashflow in China's industrial sector.

January shouldn't have been a particularly weak month for China's trade - the calendar disturbances around Chinese New Year should have flattered January's totals slightly, since Chinese New Year doesn't fall until the middle of February this year, whilst coming at the end of January last year. So, if anything, the 19.9% yoy fall in imports, generated by a 21.2% mom fall which was 1.2SDs below historic seasonal trends, was even worse than it seems.  What's more, this collapse was not simply a reflection of commodity prices falling. Indeed, in volume terms, there was surprisingly steady demand for copper, iron ore, steel products and refined oil, whilst imports of crude oil continued to climb. Of the main industrial commodities, only coal took a real battering in January. Rather, it reflected a real gap-down in inter-Asian trade, with the worst hits showing up in Hong Kong, Japan and Asean. 

The sheer scale of this fall in import demand tells us unambiguously that major parts of China's economy are still very weak. Which parts and why? The fact that the worst hits were taken by inter-Asian trade strongly suggests that China's distributors are unwilling or unable to keep supply channels stocked at the levels previously taken for granted. This was also the message hidden away in December's fall in industrial profits, when despite topline pressures, companies cut their holdings of inventories and accounts receivable more than expected. Northeast Asia's trade with China is, after all, focussed on capital goods and intermediates, so it is these which must be taking the brunt.  Overall domestic demand indicators in China are weak but not spectacularly so, but the tightening of monetary conditions imposed in 2H14 has not yet been successfully reversed. It seems that directing some financial relief on cashflow and working capital is becoming a more urgent priority.

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