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China: fine-tuning the domestic credit conditions

1/7/2021

China has registered a strong economic growth rebound since March 2020. The recovery has gradually spread from industry to services. The authorities can thus adjust their policy priorities and have begun to selectively tighten domestic credit conditions. The recent increase in corporate defaults in the local bond market is just a prelude of what is to come.

TRANSCRIPT // China: fine-tuning the domestic credit conditions : January 2021

FOCUS

FRANÇOIS DOUX

The first country to be hit by the coronavirus last year, China was also one of the first to come out of the ensuing economic slowdown. Christine Peltier, hello.

CHRISTINE PELTIER

Hello!

FRANÇOIS DOUX

How is the pulse of China’s economy as we begin 2021? What has it brought forward from the end of 2020?

CHRISTINE PELTIER

China enjoyed a very solid rebound in 2020, and it proved just as solid in the final quarter of the year. Moreover, this recovery gradually spread across the economy. At first, it was driven by industrial production and by investment in public infrastructure and real estate, which were buoyed by policy stimulus measures. Then, the manufacturing sector took advantage of a solid recovery in exports as global demand rebounded. Export growth has been accelerating for a few months. Exports even increased by more than 20% year-on-year in November 2020.

FRANÇOIS DOUX

And how is domestic consumption holding up?

CHRISTINE PELTIER

Private consumption has lagged, because households were weakened by the loss of income in the early part of the year. But private consumption growth has gained momentum since the end of the summer. This recovery has also supported activity in the services sector. Growth in services was initially slower to recover than that in industry. But it has now been accelerating for several months. Since October, growth in services has outstripped that in industry.

These sector trends will continue in the very short term. For 2020, real GDP growth is projected at 2% - the actual figure will be announced soon. For 2021, economic growth is expected to exceed 8%.

FRANÇOIS DOUX

8% in 2021. Does this mean that fiscal and monetary policy will have to adapt to this new pace of growth?

CHRISTINE PELTIER

Yes. Fiscal policy will continue to support demand in the very short term. Meanwhile, the monetary authorities are likely to adjust their targets. They have already started to tighten credit conditions very cautiously. Indeed, growth in total domestic credit has stabilised since November, after 8 months of acceleration.

FRANÇOIS DOUX

China has various monetary policy targets.

CHRISTINE PELTIER

Exactly. The central bank faces a tricky task because it has a range of targets. On the one hand, it is giving again the priority to the cleaning up of the financial sector and it wants to tighten credit conditions. On the other hand, it will not want to put the brakes on the economic recovery. It also wants to avoid exacerbating the deflationary tensions in the economy. And it probably also wants to avoid exacerbating the appreciation of the yuan. So it faces a tricky balancing act.

FRANÇOIS DOUX

So how will China’s central bank proceed?

CHRISTINE PELTIER

It is unlikely to act on interest rates. Instead, it is expected to use the prudential framework to selectively tighten credit conditions. This is something the authorities have already done in recent weeks. They have introduced prudential ratios to limit the leverage of real estate developers. They have also signalled their determination to monitor internet finance more closely. Lastly, they have announced new prudential ratios that will apply to the country’s large commercial banks.

FRANÇOIS DOUX

Final question. Should we expect an increase in debt defaults in China?

CHRISTINE PELTIER

Yes, we are expecting an increase in corporate debt defaults. This is the consequence of tighter credit conditions and measures to clean up the financial sector. It is also the result of last year’s Covid19 shock on company revenues. Lastly, it is the consequence of China’s debt excess. It is worth remembering that China went into the Covid crisis with non-financial sector debt estimated at around 260% of GDP. And this ratio climbed steeply in 2020.

Commercial banks’ non-performing loan ratios have started to increase a little bit. Most importantly, the number of corporate defaults in the local bond market is starting to rise, and this is just a prelude of what is to come.

FRANÇOIS DOUX

Christine Peltier, thank you. Coming up, the Chart of the Month with William de Vijlder.

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