Tuesday, June 30, 2009

"Chinese Credit Growth" - July 2, 2009

"Chinese equities may well be being fueled by excessive domestic credit growth" -Phil Suttle

Here is an interesting quote I took from a market commentary by Phil Suttle head of Global Marco Analysis at the IIF (The International Institute of Finance).

I question the validity for such a line of thought. Recently I have been creating an emerging bank database. Yesterday I covered the top 4-5 largest banks in China ( ICBC, China Construction Bank, China Agricultural Bank, and Bank of China; some of the largest banks in the world as well)

Most of these banks only started publicly being traded Mid 2008, but from what I remember, I believe most of their assets were deposits and that the loan to deposit ratio is relatively small. With much more deposits to loans, "explosive" credit lending may be more sustainable.

Having a discussion with Suttle this morning, he pointed out to me that much of these increases in money supply are from monetary injections, though on a whole deposit still make up a significant amount. High credit growth in China according to a Monetary Authority statement may be "worrisome."

Though one can counter and point out that high credit growth is quite normal in emerging markets. I could attest to this as I experienced such an environment when working in HSBC Vietnam during the summer 2008. There was massive amounts of high inflation (in the high teens and 20's), near currency crises issues (exporter hoarding dollars, lack of dollar liquidity), extreme interest rates(in the high teens), along with explosive credit growth. I would also like to note that there were barriers on foreign banking institutions at the time (e.g. foreign banks were still waiting to be incorporated locally; one can imagine the hypothetical credit growth with foreign banks allowed to incorporate locally).

My point is that high credit growth is a natural phenomenon seen in industrializing nations when there is high exuberance in investment and investment return sentiment. What is truly important is if the Monetary Authorities are aware of the exponential credit growth and reign in expectations and at the same time implement corrective monetary controls to make credit growth sustainable (I was actually quite pleasantly surprised with the Vietnamese Authority's ability to handle their economic situation last summer).

With these points in mind, as I mentioned before, loan to deposit ratios may make the Chinese credit growth more sustainable, and it seems that the Chinese Monetary Authorities are aware of the growing credit situation. Though, these two latter points tend to be contradicting with China's trade policy. Considering 40% of China's GDP is exports, this recession has severely reduced GDP growth as US consumption has dropped significantly (a drop in Chinese exports, an increase in US savings rates, and increase in US domestic retail recently reported). Chinese authorities are stubbornly and quite possibly dangerously suppressing their currency further in order to strain the economy for 8% GDP growth.

Currently, I would say that credit growth is sustainable, though if Chinese Authorities try to keep pushing for higher GDP growth in this recessionary environment, there is a chance they may allow credit growth to get out of control (e.g. more lending for corporates to grow business vs organic growth).

In consideration of China as a whole, outside the highly modernized cities, most of China requires huge infrastructure developments. That the amount of room for pure organic/commercial/extensive growth has HUGE potentials for commercial banking, once the right infrastructure is in place. For the Authorities to allow loan led economic growth would be ridiculous given the amount of room for extensive growth. Excessive credit growth in this view would only be sensible if credit growth was allowed only for infrastructure developments, which in turn would allow for FDI and Business loans to be dispersed into the economy.

Taking a more obtuse view of things, this current world recession is a positive occurrence for emerging markets. Long term prospects of emerging markets have not been blown away by this recession. Currently, developing nations are dealing with their own problems, which makes investing abroad secondary at the moment. This is great for emerging markets, since over the last few years emerging market growth has been explosive. When the United States fell, soon followed the rest of the world. As so, this gives investment exuberance a chance cool down and restart at a more reasonable pace (double digit growth in GDP is not sustainable for prolonged periods as history has shown us; e.g. look at the so called "Japanese miracle," Singapore, Thailand, and more recently Vietnam etc...). This recession allows for less chance of investor expectations being failed which could have lead to capital flights out of the country, severely damaging long term growth (something reminiscent of the Asian currency crisis).

One can view this recession as a period for emerging markets to cool off and take a break before resuming on its path of industrialization. Another implication from this recession is that, since emerging markets are only on a "break", it maybe the emerging markets that lead this way out of the recession followed by their more developed counter parts.

Furthermore, if the Chinese Authorities or other export oriented nations are smart they may try to diversify away from exporting to the US (this move has been seen as China trying to politically push for a new reserve currency: check this article out found by my colleague Pat China and Argentina in currency swap; I will say one thing about a new reserve currency, this maybe impossible for China to get off the dollar even if there was a new reserve currency considering the amount of US debt they hold; further more I'm sure the US would use their political muscle to prevent these scenarios from happening). Ideally, if China can diversify their export partners, this recession may not take such a strong toll on their growth.

An even better idea would be for China to take this "cooling off" period and focus on infrastructure development to foster domestic and intensive growth vs. export oriented growth (look where exported growth led Japan...).

With this being said, at least as of now the credit markets in China may not be as bubbly analyst are speculating. Though the commodity markets may be, but that is a different story...

I actually do not know much about Chinese economic development so hopefully I can take the course at the LSE next year about the "LONG economic history of China." I will certainly be looking forward to that.



  1. I agree with the points that China needs to diversify its exports and focus more on Infrastructure growth. However I am curious to see what augments the lack of exports, especially since the RIO Tinto Chinalco deal fell through which would have given the Republic valuable resources. I would expect commodity markets to be volatile depending on the China's demand for infrastructure spending.

  2. Well one thing I pointed out was the US demand, I mean they export mainly to the US. this is one of the main reasons why they buy so much US debt is so they got dollars on reserves to suppress the yuan if necessary.

    I mean other things is a weakened world demand, all countries are dealing with their own growth problems and not importing as much. The Eurozone has been hurting for the longest time even before the crash as the EURO was so strong vs the dollar, it was really surprising that the eurozone didn't intervene in the currency market which has been quite typical in their history.

    *on a side note
    To be honest the Eurozone wouldn't want to be the world reserve currency as it would make the euro much strong and make them net importers.

    One of the biggest issues is that it is a loose confederation of countries (not states like the US that is tightly knit with an overall federal institution).

    I would tend to think most arguments would say the euro becoming the world reserve currency isn't in their best interest.

    Though as your previous article points out, it would be beneficial for Asia (russia, india and china). I haven't read the article yet, but ill reply to you on the discussion board.

    Anyway getting back to the point. other factors that could make export demand worse is poor state policy as i also point out in the article. Trying to mess with the currencies too much and try to force export oriented growth could strain the markets to a collapse and totally kill the economy.

    The commodity markets are already volatile, I would watch oil fundamentals carefully as prices may get really volatile but leaving lots of room for trading opportunities.

    I mean as the media has put it recently, the markets are reacting in a way thinking that china is not in trouble yet as equities keep rallying, and commodity demand still strong (look at the AUS and NZD dollar highest interest rates in the zone, and im sure if you look at thier export data vs their historical its still relatively strong and if you look at their main partners for export you will find china being a big import from AUD and NZD).

    Thats one way to assess chinese demand for infrastructure, but you would probably have to look at greater detail as to which Chinese import is highest and going into what industry/sector and to see even if these imports are dispersed into the economy.


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