September 21, 2014 11:36 am
China risks ‘balance-sheet recession’ as stimulus impact wanes
By Gabriel Wildau
China has launched a fresh effort to boost its flagging economy with cash injections by the central bank, but signs are mounting that monetary stimulus is losing its effectiveness as debt-ridden companies lose their appetite for borrowing even at low rates.
‘Mini-stimulus’ measures launched since April have focused on increasing the supply of money and credit. Last week the central bank moved to inject $81bn into the banking system via loans to the five biggest banks. That followed targeted cuts to the required reserve ratio for small banks and a loosening of the regulatory loan-to-deposit ratio that gave banks greater freedom to expand lending.
Authorities want banks to channel those funds into the real economy, but bankers and analysts say that weak credit creation in recent months is due more to lack of demand from borrowers than to constraints on bank lending.
That raises the spectre that China may slip into a so-called “balance-sheet recession”, the kind of economic slump in which monetary policy loses its effectiveness because highly indebted companies concentrate on paying down debt and remain unwilling to borrow even when interest rates fall. Weak demand for goods amid a slowing economy further depresses appetite for investment.
“Anyone who runs a company with high leverage is very sensitive to the prospects for final demand,” said Richard Koo, the Nomura economist who pioneered the concept of a balance-sheet recession in his analysis of Japan’s post-bubble stagnation in the 1990s.
More recently he has applied the same analysis to the post-crisis economies of the US, European Union, and the UK, where huge expansions of the base money by central banks have largely failed to spur bank lending to the real economy.
“If everyone is happy and spending big, then leverage isn’t a big issue,” said Mr Koo. “That was the way Japanese companies operated until the end of the 1980s. But once things reverse, they have to be super cautious. At least some Chinese companies are now acting the same way.”
Indeed, a central bank survey released on Friday showed that bankers saw declining demand for loans in the third quarter, while a separate survey showed that manufacturers are increasingly pessimistic about the economy.
The survey results help to explain data released earlier this month showing that bank loans outstanding rose by only 13.3 per cent year on year in August, the weakest pace since 2005.
Analysts still believe the Chinese government could spur credit and investment growth with aggressive monetary easing, including an interest-rate cut and so-called “window guidance” from regulators instructing banks to boost lending.
But bankers say that good lending opportunities have become increasingly scarce, even as regulators have relaxed the enforcement of rules like the maximum 75 per cent loan-to-deposit ratio, which has long served as a big constraint on bank lending.
“The LDR has been relaxed, and liquidity has increased, but it’s still hard to place loans. When the (stimulus) news broke, banks all rushed to buy bonds. The money hasn’t flowed into the real economy,” said an executive at a midsize commercial bank in Shanghai.
Rising debt is at least partly to blame for waning appetite for new borrowing. The massive stimulus that China’s economic managers launched in response to the financial crisis sent China’s overall debt-to-GDP ratio soaring to 251 per cent by the end June, from 147 per cent at the end of 2008, according to Standard Chartered estimates.
Mr Koo and others say a fully-fledged balance-sheet recession would require a much steeper fall in Chinese asset prices. Property prices have fallen for four straight months, but the magnitude of the fall is still far below the catastrophic collapses seen in Japan in 1990 or the US in 2008.
The theory of a balance-sheet recession implies that when impaired corporate balance sheets weaken the private sector’s appetite for borrowing and investment, the government must fill the gap with fiscal spending.
China dabbled in this approach earlier this year, as the fiscal deficit briefly spiked amid increased spending on rail and other areas. But if private spending weakens further, Chinese policy makers may be forced to overcome their traditional aversion to big fiscal deficits and adopt more muscular stimulus.
George Magnus, senior economic adviser for UBS, argues that China should welcome the fall in borrowing and accept the current growth slowdown as the inevitable cost of preventing a fully-fledged balance-sheet recession down the road.
“If the credit-creation/debt-accumulation model is permitted to continue for much longer, I think it’s increasingly probable that over-leverage in the non-financial company sector could precipitate an interest-rate insensitive slump in investment,” said Mr Magnus.
Twitter: @gabewildau
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