FT Confidential Research
China July money data show softer deleveraging approach Premium

PBoC treads cautiously on financial system risk as Congress approaches

YESTERDAY by: FT Confidential Research

• Another drop in M2 growth is a sign that deleveraging is ongoing, but the authorities have adopted a softer approach than earlier in the year.
• We believe they have tweaked their strategy ahead of the 19th Party Congress to channel more credit through better-regulated parts of the system.
• Guaranteeing short-term stability makes political sense but shuffling loans around the system again fails to address how China will tackle its outstanding debt pile.
  

July monetary data from the People’s Bank of China (PBoC) presented more evidence of the government’s campaign to rein in borrowing and lending activities in the Chinese interbank market. However, the data also showed how the authorities have recalibrated their approach to deleveraging to ensure stability as a key Communist Party meeting nears.

Growth of M2 — a broad measure of money supply that includes cash, checking and savings deposits, and other time deposits — slowed in July to yet another new low of 9.2 per cent. However, total social financing — the PBoC’s broadest monthly measure of financing activity — was up sharply on July 2016 and rose on an outstanding basis (see chart).


The relative strength in total social finance indicates less forceful deleveraging than had been expected earlier in the year. That said, we do see shifts within credit flows that show riskier funding channels are being affected by the crackdown.

For example, the strength of trust financing shows loans being encouraged away from less-regulated parts of the shadow finance system. Other components of shadow finance tracked in the aggregate finance data remained weak while this was the biggest July on record for trust loans (see chart).



Bank lending was also relatively strong. July saw the fastest increase in loan growth this year, including Rmb433.2bn in new medium to long-term corporate loans. The recent strength in corporate loans is notable as it has occurred even as average lending rates have increased (see chart). We believe this shows that companies have become more reliant on plain vanilla bank lending channels as deleveraging closes off other sources of credit.



In this case, increasing bank loans may not be a positive for economic growth if this simply means off-balance-sheet loans are being brought on to bank books.

Bond financing also rebounded in July, increasing by a net Rmb284bn after seven months of weak, or even negative, growth. The end of the bond market rally was among the clearest early signs of the government’s push to deleverage the financial system. Bond yields have fallen from the multiyear highs seen earlier this year but remain at relatively high levels (see chart). While the authorities may be quietly encouraging more issuance, it remains to be seen if this is the start of a meaningful recovery.



A gentler regulatory approach
Despite mixed signals in the PBoC’s latest data, the central bank is pressing ahead to rein in borrowing activities in the interbank market, albeit at a gradual pace. In its most recent monetary policy report, the PBoC confirmed that negotiable certificates of deposit (NCDs) will be included in its calculations of interbank liabilities as part of the macro-prudential assessment (MPA) that it uses to police banks. NCDs have become an important source of leverage for smaller, deposit-starved institutions (see chart) and from next year they will be included in calculations that restrict interbank liabilities to one-third of a bank’s overall liabilities.


This is a less aggressive outcome than had been feared by market participants earlier in the year. In April, market talk was of more immediate enforcement and a lower liability threshold than 33 per cent. Including NCDs, small and medium-sized lenders have interbank liabilities equivalent to just 25.8 per cent of total liabilities, according to an estimate from Tianfeng Securities, a domestic brokerage, suggesting this new rule will not be a major constraint on interbank borrowing.

Going slow before the Congress
Outside the interbank market, a high-profile deleveraging push is ongoing, including a crackdown on overseas dealmaking by private conglomerates like Dalian Wanda. Inside the market, the regulatory stance has softened considerably from April, when state media was warning of a “regulatory windstorm” to rein in borrowing.

The PBoC began relaxing its stance ahead of the end-of-quarter in June, responding to tightening liquidity conditions with increased provisions of funding. The China Banking Regulatory Commission is also taking a softer line after its request for banks to check over their loans to the big conglomerates triggered market volatility.

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During the recent National Financial Work Conference, China’s leadership identified the threat posed by financial system excesses and called on regulators to better co-ordinate to control these risks. While that means tackling abuses in the financial system, the PBoC and other regulators are also avoiding moving too aggressively and risking a systemic blow-up.

Where it once looked like the authorities would attempt to outright shrink the shadow finance system, we now see a more gradual attempt to shift credit flows from the more shadowy parts of the system to its more transparent areas.

Going slow may be a politically sensible approach ahead of the 19th Communist Party Congress, which is expected to be held in the fourth quarter. A healthy flow of credit guarantees short-term growth ahead of this important meeting — the “known unknowns” of China’s financial system are a potential source of economic instability.

However, this amounts to shuffling more credit around the system while failing to answer the fundamental question of how the government finally intends to deal with China’s debt problems.

Answers may come after the Congress.