"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.
-Alex
