Photographer: Tomohiro Ohsumi/Bloomberg

China Shows It Can Clean Up Credit Without Killing Off Growth

  • PBOC says less off-balance sheet lending has impacted M2
  • Credit’s still going to economy as new loan pace increases

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China’s monetary authorities are attempting a feat that would test the world’s best financial overseers: Damping down more speculative parts of the financial system without choking off credit to the real economy.

So far, they’re pulling it off.

A campaign against excess leverage has helped squeeze growth of M2, the broadest measure of money supply, to a record low in June even as new loans and aggregate financing exceeded expectations.

It may seem counter-intuitive that credit can be expanding faster at a time when the supply of money isn’t -- but the People’s Bank of China has an explanation.

Slowing M2 growth shows more efficient use of credit and that will be the "new normal," said Ruan Jianhong, the central bank’s spokeswoman and head of its statistics department, according to a statement.

Policy makers have tightened regulation to rein in leverage and curb risky credit as they strive to reduce financial risks, even as the overall debt burden in the economy continues to rise. Though tighter bond and money market rates are damping down speculative lending, June’s data indicates credit still is flowing to corporations and households.

The “top leadership is frustrated that money in this economy refuses to go to the right places,“ said Andrew Polk, co-founder of research firm Trivium China in Beijing. “So far, tighter financial regulation is providing the beginnings of a remedy.”

Stop Go

Financial institutions’ off-balance-sheet lending has moderated, which triggered slower deposit creation, said Ruan. Milder M2 growth is the result of financial deleveraging, and investors shouldn’t read too much into the downturn in money growth, she said.

“Beijing is adept at saying stop with one hand and go with the other,” said Andrew Collier, an independent analyst in Hong Kong and former president of Bank of China International USA. A financial work conference scheduled for this weekend will focus on reducing risky credit while bank lending continues to “boom along,” he said.

Because slowing M2 growth is caused mainly by reduced lending to non-bank financial institutions and deleveraging, especially of shadow banks, the central bank will persist with its risk-reduction policies, said Gene Ma, chief China economist at the Institute of International Finance in Washington.

Derek Scissors, chief economist at the China Beige Book in Washington, says there’s still more for the central bank to do. While record low M2 is the right trend, it’s still expanding too fast to bring about overall deleveraging, he said.

"What most China observers call deleveraging is actually slower, modified, additional leveraging," said Scissors. At least publicly, policy makers aren’t willing to get to grips with the much lower M2 growth that’s needed for several years to bring debt levels under control, he said.

China’s economy is on a slowing trend anyway and few believe that de-risking the financial sector can happen without being an additional drag on expansion.

That indicates China’s growth may disappoint, said Michael Every, senior Asia-Pacific strategist at Rabobank in Hong Kong. “Even the crazy aggregate financing figures are not enough to stop that slowing momentum.”

— With assistance by Kevin Hamlin

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