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Strong credit not a surprise, policy stance to be sustained

We received a lot of questions regarding the higher-than-expected credit figures in January. How to interpret it? Does it represent a shift in the policy stance of the People’s Bank of China(PBOC)? What are the implications on the growth outlook?

China’s new loan creation came in higher than expected at 1.32 trillion yuan (US$218 billion) in January (consensus: 1.1 trillion yuan), and total social financing (TSF) printed a new record of monthly high at 2.58 trillion yuan.

Q1: How to interpret the credit figures in January?

TSF printed a new record high at 2.58 trillion yuan in January. However, detailed analysis suggests that the message is not as upbeat as the headline numbers may suggest.

First, based on our calculation, TSF (stock) rose by 17.4 percent year on year in January, compared to 17.8 percent in December. In sequential term, our calculation suggests that TSF rose 16.5 percent quarter on quarter by January (compared with 17.1 percent quarter on quarter in December). That is, the high credit in January is mainly driven by the seasonal pattern (the front-loading phenomenon) and does not change the credit slowing phenomenon that was observed in the second half of 2013.

Similarly, yuan loans rose 1.32 trillion yuan in January. This accounted for 13.5 percent of our full-year loan forecast (9.8 trillion yuan, or 13.8 percent increase), which is roughly in line with the historical seasonal pattern.

Second, compared to the credit data in January 2013, the positive news is that new loan creation is higher (1.32 trillion yuan this January vs. 1.06 trillion yuan last year). Bank acceptance rose 490 billion yuan this January (vs. 580 billion yuan last January), which is a common phenomenon at the beginning of the year because it could be used to seize credit quota but at the same time offers the flexibility to be sized down. Interestingly, the pace of increase for both trust loans and corporate bond slowed down dramatically in January, almost fully canceling out the increase in yuan loans. The softening in trust activity may reflect the effect of crackdown of non-standard credit products and severe concerns about the possible trust default, while the weak bond issuance may reflect the consequence of weak bond market performance in recent months.

If we use the sum of medium- and long-term loans, trust loans, entrust loans and bond as a proxy for credit that supports medium- and long-term activities, it printed at 1.35 trillion yuan in January, somewhat higher than 1.22 trillion yuan in January 2013 but lower than 1.42 trillion yuan in March 2013.

Overall, the January credit figure is larger than expected, but does not come as a big surprise. What is worthy of special attention is the shift in TSF composition, and the credit dynamics in the next few months.

Q2: Why did M1 growth drop significantly in January?

M1 growth dropped significantly to 1.2 percent year on year in January (vs. 9.3 percent in December). Why?

Traditionally, a large drop in M1 growth (or a large gap between M2 and M1 growth) is perceived to be a good indicator of weak economic activity. The reason is as follows: as M1 consists of M0 and the liquid part of corporate deposit, it reflects corporate’ near-term intension to spend. A drop in M1 growth (or relative to M2 growth) suggests that corporate has less incentive for near-term investment, and hence domestic demand tends to be on the soft side.

Is it still the same reason this time? Indeed, we expect that China’s growth momentum to slow down from 8 percent quarter on quarter in the fourth quarter of 2013 in to 7.2 percent in the first quarter of 2014, which is consistent with the above interpretation. However, we would be cautious not to over-interpret it.

First, there seems a seasonal pattern of large drops in M1 growth in January in recent years, probably related to the Lunar New Year effect (salary and bonus payments ahead of the holiday). A related phenomenon is substantial shift from corporate deposits to household deposits before the holiday and huge flows in the reverse direction after it.

Second, M1 growth may be affected by the emergence of new financial products available in the market. On the deposit side, demand deposit is facing increasing competition from alternative deposit options (such as interbank deposits and wealth management products that generate higher returns). Such deposit shift could be an additional factor behind the drop in M1 growth in January (and more generally in recent years).

Q3: Does it mean a shift in monetary policy stance?

We maintain our forecast on monetary policy stance: policy rate and reserve requirement ratio will stay unchanged, but credit tapering will continue, pointing at a tightening bias. In particular, we expect TSF to increase by 18.5 trillion yuan (or 16.2 percent year on year) and bank loans to increase by 9.8 trillion yuan (or 13.8 percent) throughout 2014.

The PBOC, in its Monetary Policy Report for the fourth quarter of 2013,  concludes that the fast growth in monetary credit and TSF observed in early 2013 has been effectively contained, and it provides a favorable environment to proceed on economic restructuring and to deal with financial stability concerns. We think that the PBOC will maintain the current policy stance.

Indeed, the PBOC had two repo operations last week, withdrawing a total liquidity of 108 billion yuan (48 billion yuan on February 18 and 60 billion yuan on February 20). In our view, the reasons are twofold. First, the PBOC wants to send a signal that monetary and credit policy will not be eased, especially given that January credit figures are stronger than expected. Second, the aggregate liquidity in the market may improve further in the near term, due to the seasonal pattern of deposit return after the Chinese New Year, the strong trade data in January, and the fact that all reverse repos had matured (no automatic withdrawal of liquidity).

Q4: How would credit tapering affect the growth outlook in 2014?

China’s January macro indicators sent rather mixed message overall: with strong trade and credit/TSF figures, and weak Purchasing Managers’ Index as well as Producer Price Index (highlighting lack of corporate pricing power and lingering over-capacity problem in the manufacturing sector). The noises related to the lunar new year holiday effect and the fact that there is no official data release of domestic economy activity (including industrial production, fixed investment and retail sales) for January makes it harder to gauge the near-term momentum of the overall economy.

We maintain our forecast of further easing in growth momentum (7.2 percent quarter on quarter in the first half of 2014 and 6.8 percent in the second quarter). An important assumption behind our forecast is the continuation of credit slowing. TSF growth came down from 20.4 percent year on year to 17.8 percent in the second half of 2013, and is expected to further moderate to 16.2 percent in 2014.

The strong credit/TSF data in January helped to reduce downside risks in the near term (as evidenced in the drop in 7-day repo rates and 1-year government bond yields), but it does not represent a shift in monetary policy stance. Looking forward, credit dynamics will affect the growth outlook via three channels.

The first channel is via the direct relationship between credit and economic activity. The historical relationship shows that TSF growth tends to lead GDP growth by about two quarters. To that end, the further weakening in the growth momentum in the first half of 2014 is a result of credit slowing in the second half of 2013.

The second channel is via the potential interest rate channel. Since May 2013, 3-month Shibor has climbed up by about 170 basis points, which has caused 1-year government bond yield to rise by about 110 basis points. But there seems little pass-through effect to the lending rates to business borrowers. Average bank lending rates only rose by 29 basis points in the second half of 2013 and average underground lending rates were quite stable. If there is a delayed pass-through effect, business borrowers will face higher funding cost. That will hit business sentiment.

The third channel is via the compositional shift in TSF. The PBOC has reiterated to “better utilize new credit, activate existing credit stock.” The objective is to crack down speculative financial activities, and make sure that credit supports the real business sector, especially the more productive sectors. However, this objective seems to be beyond the capacity of the central bank. It needs the support from regulators, as well as other reforms that help to restore market discipline and efficiency in the financial system (e.g. introducing a hard budget constraint for local governments and writing-off non-performing loans).




 

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