Despite the risks that the COVID-19 pandemic has introduced into China’s economy, the country has recovered quickly and been relatively successful in stimulating growth. However, policymakers in Beijing are now out of the fire and into the frying pan as they turn their attention to addressing the more systemic issues that could hinder China’s long-term recovery. One of these issues in particular, the unprecedented credit surge that started in the summer of 2020, has continued to gain steam.
Higher-than-normal quantities of medium- and long-term loans to non-financial companies and households has culminated in this credit surge, which has in turn brought about worries of inflation and uneven recovery. Inflation, for instance, could rise should credit be allowed to accrue unabated and further swell Beijing’s high debt-to-GDP ratio. Similarly, China’s uneven economic recovery could continue to grow lopsidedly should loose credit lending regulation continue to reign free in the more influential sectors of the Chinese economy, thus spurring quickened growth in some areas and stagnation in others.
Consequently, Beijing began to tighten its grasp on surging credit levels last February through a multitude of policies; however, there exist concerns that this regulation may not provide adequate support to the unbalanced economy.
China’s Credit Boom
Beijing’s efforts to spur economic activity amid the pandemic directly unleashed the current credit boom. Between the summer of 2020 and February 2021, the market saw a flurry of loans, lenient bank policies, and targeted stimulus measures – all supported by a conviction to maintain the country’s unprecedented economic recovery. According to the People’s Bank of China, in January 2021 alone, aggregate financing, also known as social financing, reached CN¥5.17 trillion, marking a dramatic 201% rise from the CN¥1.72 trillion in financing at the beginning of December 2020.
Financial institutions were significant contributors to the staggering amount of aggregated finance throughout the month of January, extending the highest recorded levels of new loans in over 30 years at CN¥3.58 trillion. Most of these loans were distributed to non-financial companies and households, from which banks collected nearly CN¥3 trillion yuan.
During the pandemic, corporate financing was easy to access due to lenient lending policies. However, once credit growth began to slow in February 2021, waves of credit defaults spurred questions over the sustainability of China’s debt load, particularly among property developers, local government financing vehicles, and coal producers. Massive property developers like China Fortune Land, which defaulted on US$1.3 billion of debt in March, and Tsinghua Unigroup, which defaulted on US$200 million of debt at the latter end of 2020, painted the headlines. Beijing rallied to action on the news, moving forward with delicate financial de-risking efforts while simultaneously defending against further major defaults.
Combating the Credit Boom with Financial De-Risking
Beijing launched a variety of measures intended to bring the credit surge under control. Most prominently, policymakers first implemented a policy that allowed long-protected state-owned enterprises to default on loans. While perhaps unconventional in the traditional sense of “de-risking,” it worked in a similar fashion by removing the support beams and placing the burden of default risk on financial institutions. Although these state-owned firms have often been bailed out by the state’s coffers, Beijing sought to send a message throughout the economy that irresponsible financial activity would no longer be tolerated and that even the most protected companies were to bear the burden of their decisions. Banks, by extension, who would ultimately pay the price of defaults, were thus incentivized to be more disciplined in their lending practices.
Additionally, Chinese policymakers embraced targeted deleveraging initiatives that will continue to unfurl throughout the rest of the year. In January and February, regulators implemented deleveraging measures on a sector-by-sector basis, focusing primarily on the overheated property market in China’s largest cities. As such, the PBOC introduced the “three red lines.” The new policy seeks to slow credit growth among property developers and ensure sustainable growth within the industry. The three red lines place limits on debt-to-equity, debt-to-cash, and debt-to-assets growth levels, capping annual increases to no higher than 15%. Given the headline-worthy defaults among property developers, in addition to unsustainable growth in real estate prices, property development was the sector deemed most at-risk at the time; however, the deleveraging campaign could subsequently be introduced to other industries with bubble-like qualities.
Credit Miracle or Economic Danger?
China is walking upon a tightrope in its response to the credit boom. Premature tightening of monetary policy could introduce additional financial instability in both China’s domestic economy as well as the global economy at large. Yet, domestically, economists are calling for a delicate and narrowed tightening of credit growth due to concerns over a meteoric rise in China’s debt-to-GDP ratio. Stemming from last year’s credit surge, China’s debt-to-GDP ratio rose by an estimated 281% to its highest level on record.
On the other hand, if monetary tightening policies are not properly balanced, China’s economic recovery could relapse. On the heels of the pandemic, businesses have extremely lean balance sheets and many have only survived due to easy access credit. For example, many of the large defaults that occurred in late 2020 and early 2021 came after short waves of tightening, marked by larger-than-normal monetary moves, which in turn shrunk broad money supply. Defaults like those at Tsinghua Unigroup Co. and the state-run Yongcheng Coal and Electricity Holding Group Co. serve as stark reminders of the reverberations that tightened credit access introduces into the economy. The delicate balance that Beijing faces, then, is one of deflating asset bubbles while minimizing the economic fallout of tightened monetary policy.
Looking Forward: A Classic Wait-and-See Approach
The tightrope that must be walked between uninhibited economic recovery and an unsustainable credit access will continue to challenge policymakers in Beijing. While the PBOC has paused the discussion on monetary tightening for the time being, China’s overheating sectors are likely to call leadership back to the table to devise a surgical approach to sector-by-sector deleveraging. For now, all we can do is wait as China – and the world – continues its ascent out of the economic pit created by a once in a lifetime pandemic.