CHINA STEEL INSIGHT 

China’s credit crunch is misunderstood

The recent reduction in reserve requirements for Chinese banks was interpreted by commentators and analysts in a remarkably uniform fashion: China is now said to be in loosening mode. The consensus is that previous tightening measures in China had gone too far. Private sector firms, without the preferential bank financing enjoyed by state owned companies, were facing a potentially perilous credit crunch. This was threatening to derail economic growth.

However, to take this view is to ignore the compelling evidence that the private sector remains well funded. It also overlooks the fact that high liquidity amongst these companies is indirectly leading to a credit crunch in the state sector. This suggests that fiscal loosening in China is likely to be substantially different to the easing most are anticipating.

What evidence is there for a credit crunch in private industry?

Those arguing that China needs to boost bank lending to the private sector often point to the much publicised problems in Wenzhou, capital of Zhejiang province and the heartland of Chinese private entrepreneurship. Bankruptcies, fleeing bosses and even suicides, reflect the credit crisis which is supposedly pervading private sector manufacturers.

But how much can be read into these individual cases? Indeed, quantitatively, what evidence is there for a credit crunch in private industry as a whole? Figures published by China’s National Bureau of Statistics, would suggest, none. Fixed asset investment by private sector companies is booming, highlighting that the majority of these companies are flush with cash - not struggling for credit. Investment by these enterprises in the ten months to October 2011 was 33% higher than in the same period last year. This compares with a 25% increase in fixed asset investment across all industries. A private sector, supposedly at the forefront of a credit crisis, is outspending other sectors.

A state sector credit crunch

Evidence for a credit crunch is more prevalent in the state, than in the private sector. Fixed asset investment by government owned companies has grown only 12% so far this year. More pointedly, investment in infrastructure is up just 4% and in recent months has fallen 7% below last year’s levels.

Part of the reason for this slowdown lies in the fact that financing for infrastructure works is dependent on the official banking system. The initial impact of a tightening in bank lending is more likely to be borne by these projects and state owned companies, than private sector firms. The latter are more easily able to tap into informal lending networks and utilise their own, often substantial, funds.

What is surprising is that cash strapped infrastructure projects are not receiving more government funding. A series of scandals in the railway industry is partly to blame but, disregarding rail transportation, growth in infrastructure investment was still a feeble 7% in the first ten months of the year.

Many analysts have argued that government spending on these projects has been reduced as a result of the squeeze on local government finances as their land sales fell. Yet there is little evidence of a slowdown in spending by provincial authorities. Fixed asset investment at a local level is up 28% so far this year. A 9% contraction in outlay on centrally managed projects suggests that regional finances are being boosted by reallocated state expenditure.

Affordable housing is increasingly dominating government spending

Investment in infrastructure has slowed not because of a reduction in government expenditure but because it has become increasingly focused on housing - to the detriment of infrastructure. The administration is committed to boosting the supply of affordable first homes and in March this year unveiled its plan to start construction on 10 million economic housing units in 2011.

Substantial investment from private sector real estate developers had been central to this strategy. However, private sector involvement on this scale failed to materialise and central and local authorities have increasingly had to plug the gap. By the end of October central government spending in this area was 50% more than its initial allocation for 2011 of RMB 103 billion.

The main problem facing investment in these projects is that there are substantially larger returns available on higher-end property developments. The government recognise this and has introduced lending and purchasing restrictions to reduce what is, in large part, speculation-driven demand for these houses. However, these policies are not having the desired impact and government investment in economic homes continues to substantially outpace that by a private sector transfixed by the profit to be made elsewhere.

These measures have failed for the same reason that private sector spending has continued to record high growth: money supply outside of the official banking system has remained strong. This has benefited private sector firms but disadvantaged state owned companies. It has also meant that where these funds are invested is largely beyond government control. This has undermined much of the administration’s restrictions on the real estate industry, by allowing investment in and demand for speculative real estate to continue. Surging state expenditure on housing and a decline in infrastructure spending is one consequence of that.

A different kind of easing

Rather than witnessing a fiscal tightening policy which has gone too far, there is every sign that excess liquidity from 2009’s lending spree remains. If the cut to the reserve requirement ratio boosts bank lending, it will be directed towards the state, not the private sector. Relief for private industries, especially if the global economic crisis intensifies, is more likely to come in the form of tax cuts than easier access to credit.

This is not the type of easing that most were looking for but then the anticipated outcome was never what was actually required. If reduced bank reserve requirements do not signal the start of credit relief for the private sector then falling property prices might. These indicate that the government’s real estate policy is beginning to bite. The measures, however, are far from achieving their goal of redirecting investment from speculative real estate to affordable housing. A property slowdown could be the signal for a shift to a loose fiscal policy but only after real estate restrictions have first actually achieved their objective.

In the medium term falling property prices might still provide the much sought after stimulus for growth. If a real estate slowdown runs the course that the authorities want, it should reduce demand for speculative real estate and divert private sector resources to the construction of affordable first homes. This, in turn, could lead to a rise in infrastructure spending from the corresponding release of government funds. This would be positive news for industries such as steel and cement. However, those still anticipating a fiscal stimulus for the private sector will first have to wait for the effects of the last one to fade away.

For further information please contact rhalpin@meps.co.uk 0044 (0)114 2750570
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