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Chi Lo

Cutting down the leverage that has supported mainland economic growth will be a multi-year process, once it gets going.
The question for investors is whether Beijing is serious, or just paying lip-service to the effort.
The first clue to the answer is to be found in the composition of aggregate liquidity flows, as the types of credit in the economy are as important as the absolute amount.
Since 2014, Beijing has started to improve the structure of the liquidity flows by restricting the growth of shadow banking credit, including entrusted loans, trust loans, bankers’ acceptance bills and curb-market lending.
In early 2015, shadow banking credit accounted for 12.4 per cent of total annual social financing (TSF) flows, down from a peak of 41 per cent in early 2013.
During the same period, the share of bank credit flows rose to 77 per cent from less than 50 per cent and capital market financing rose to more than 15 per cent from less than 10 per cent, indicating Beijing’s effort to shift credit flows from the opaque shadow banking market to the better regulated banking and capital markets.
The second clue is in Beijing’s policy manoeuvres in economic cycles.
How the government chooses to conduct monetary easing to fight slowing growth is crucial to deleveraging. Price-based changes, such asto interest rates and bank reserve requirements to encourage the expansion of credit, rather than simply adding to the quantity of money supply, helps banks price risk and allocate capital better. It also avoids an indiscriminate build-up of debt that may turn bad.
How fast China liberalises deposit rates will determine how fast the implicit subsidy to banks is eliminated and how rapidly lending decisions can be made on a truly commercial basis.
The third clue will be the trend for non-performing loans (NPLs).
After the 2008-09 global financial crisis, Beijing flooded the economy with 4 trillion yuan of credit, which ultimately funded a vast amount of unproductive investments.
NPL ratios though have remained below 1 per cent until recently, as defaults were suppressed and bad loans rolled over. Allowing uncompetitive firms to fail is necessary as it delivers deleveraging and fosters the emergence of productive (mostly private) firms to drive the “new” economy. Since 2014, the number of defaults by small companies has risen along with NPLs.
Beijing has also begun to pare financial system debt by introducing a swap scheme in March 2015 to reduce local government borrowing costs.
The scheme replaces short-term (typically one- to three-year) high-risk local government financing vehicles and other local government debt instruments with longer-term (five- to seven-year) bonds issued directly by the Ministry of Finance and local governments through the relatively better regulated and transparent bond market.
Granted, this programme will not fully resolve the local government debt problem. Other structural reforms are still needed. These will have to involve the private sector, such as the public-private partnership scheme and the disposal of local government assets, in order to have market discipline help resolve moral hazard in the system.
The bond swap programme should be seen in conjunction with the revision of the Budget Law in August 2014, which allows local governments to borrow in capital markets under strict conditions and introduces greater transparency in the local budgets. This lays the groundwork for proper pricing of mainland credit risk.
Under the revision, local governments are required to publish their budgets and final accounts reports within 20 days of the legislature’s approval. That makes public all the budget and audit information that underlies local government debt.
The implications of the Budget Law revision-cum-bond swap programme are positive, helping mitigate systemic risks and thus reducing the credit risk premium.
It will bring down the local government yield curve, as high-risk local government debt vehicles are replaced by high-quality government bonds. However, the expected increase in the supply of local government bonds under the swap programme may put some upward pressure on the long-end, and thus steepen the yield curve.
Chi Lo is senior economist at BNP Paribas Investment Partners


Signs emerge that Beijing has begun deleveraging growth

The imposing building of the People's Bank of China, the country's central bank, as monetary authorities cut down the leverage which has supported growth in a process that will take years. Photo: Bloomberg

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Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


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Macroscope | Signs emerge that Beijing has begun deleveraging growth