De-risky business: China’s Xi wisely tries to rein in easy credit

Chinese President Xi Jinping recently convened a group study meeting of the Politburo to hear from the top financial regulators about their efforts to rein in financial risks:

“We must not neglect a single risk factor or … hidden danger,” Xi was quoted as saying by Xinhua, the official press agency for the People’s Republic of China. “Safeguarding financial security is a strategic and fundamental matter for China’s social and economic development.”

{mosads}The meeting served to warn the regulators that they would be held responsible for financial stability, but also to provide elite backing to their efforts to rein in shadow banking. In recent weeks, the China Banking Regulatory Commission has taken measures to prevent banks from using wealth management funds to invest in their own investment products. 

Banks will also have to fully provision for the investment products that are based on bank loans. More generally, the four regulators (the central bank plus banking, securities, and insurance regulatory commissions) are trying to coordinate better in order to prevent “regulatory arbitrage,”  which occurs when financial firms exploit differences in the rules that govern similar investment products depending on which regulator supervises the issuing institution.  

These tightening moves should be understood in terms of the normal stop-and-go pattern of Chinese macroeconomic policies. The most important priority for 2017, a political year that culminates in the 19^th Party Congress, is economic growth. China’s GDP growth accelerated in the first quarter to 6.9 percent year-on-year, well ahead of the target of 6.5 percent. 

This was underpinned by substantial monetary stimulus. The stock of total social financing (TSF), a broad measure of money and credit, was up 12.5 percent at the end of the first quarter compared to the year before. This is very rapid growth of credit for an economy with a real growth target of 6.5 percent. That is the “go” part of the cycle. Now that real growth of the economy is solid, comes the “stop” phase. 

China’s growth in recent years has been accompanied by an alarming rise in leverage. Total debt now is about 260 percent of GDP. As a high savings economy with a state-owned banking system and a closed capital account, this does not necessarily presage an immediate financial crisis. 

But it is fair to say that the leverage cannot go on rising forever in the way that it has in the past several years. So, the authorities are wise to take steps to rein in the riskier lending and the more opaque savings instruments. 

The financial measures have had an immediate effect. Interest rates in the inter-bank bond market went up, signaling tighter credit conditions. The Shanghai stock market has tumbled about 4 percent over the past three weeks, but it is still up 50 percent from three years ago, so it is hard to worry too much. The recent moves simply take a little froth off of the market. Prices for metals, such as iron and copper, fell as well, in anticipation of less construction going forward. 

Production data for April are just starting to come in. The Purchasing Managers Index (PMI) for manufacturing fell to a six-month low of 51.2 from March’s near five-year high of 51.8, but the reading is still in expansion territory. The PMI for the services sector also slowed, to 54.0 from 55.1 in March. This continues the recent trend of the services sector leading while industry grows more slowly. 

In my view, this gradual slowdown is positive. China’s growth will be more sustainable if it slows down towards 6 percent, or even lower. Keeping the growth rate at higher levels depends on stimulating investment through loose credit. Given the excess capacity that still exists throughout much of the economy, that is a risky strategy that could easily end in a financial crisis.  Better to have the economy slow down to a more sustainable rate based primarily on consumption. 

Naturally, a slowing Chinese economy means that there will be less demand for imports, especially of metals and energy. So, China’s partners, especially commodity exporters, will feel some chill from the Chinese tightening, but better to have a little chill then to eventually have to deal with a full-blown financial crisis. 

We do not need to worry that there will be too rapid a deceleration this year. If the growth slowdown threatens to go too far, the authorities can quickly hit the accelerator again and take the economy back into a “go” cycle. 

David Dollar is a senior fellow in the John L. Thornton China Center at the Brookings Institution.

The views expressed by contributors are their own and not the views of The Hill.