China pessimists argue that the authorities’ efforts to stimulate the economy have resulted in another unsustainable credit boom. The credit surge, they claim, has merely delayed an economic downturn and increased its probable magnitude, while further weakening banks’ balance sheets. Are they right?

Widely-monitored credit / financing measures do not suggest a renewed lending explosion. Annual growth of renminbi bank loans to households and non-financial enterprises was 14.5% in March, close to its average of 14.9% over 2011-15 (five years). Annual growth of “total social financing” – a broader measure of fund-raising by households and non-financial enterprises encompassing non-bank loans and issuance of bonds, acceptances and equities – was 13.4%, significantly lower than its 2011-15 average of 17.3% and far below a 35% peak reached in 2009.

The pessimists, however, highlight a less widely-followed series measuring total domestic credit extended by banks. This rose by an annual 25.4% in March versus average expansion of 17.4% over 2011-15. Recent growth is the fastest since the 2009-10 credit boom – see first chart.


The big divergence between the growth of this measure and that of bank loans to households and non-financial enterprises reflects a surge in credit to the government and the non-bank financial sector. Bank credit to government, net of government deposits at banks, rose by an annual 87.4% in March, contributing 4.3 percentage points to the 25.4% growth of total domestic bank credit. Credit to the rest of the financial sector, meanwhile, rose by 68.3%, contributing 8.2 percentage points to total credit growth.

The increase in government credit is partly a consequence of fiscal stimulus. The authorities have responded to a weak economy by running an increased budget deficit financed through the banking system.

The government credit surge also reflects the impact of the local government debt swap programme, under which municipal authorities have been issuing bonds, mostly bought by banks, with the intention of retiring more expensive bank loans incurred by their subsidiary enterprises (local government financial vehicles). These subsidiaries are classified as “non-financial enterprises” so their borrowings are covered by the headline RMB bank loans and total social financing measures. To the extent that debt has been repaid, annual growth of these measures will have been “artificially” depressed, possibly by several percentage points. Even adjusting for such an effect, however, growth would not be particularly strong by the standards of recent years.

The rise in government credit, therefore, is unconcerning and may be serving to improve the quality of banks’ assets, since government lending has the implicit backing of the central authorities (unlike loans to local government financing vehicles).

The surge in credit to the non-bank financial sector is more worrying. An FT article this week suggested that banks have been using “investments” in intermediaries such as trust companies, brokerages and special purpose vehicles to hide risky loans to households and non-financial enterprises. Such investments or “debt receivables” are classified as credit to the financial sector. The FT stated that the banking regulator is cracking down on this practice and will require banks to make full provision for debt receivables based on loans.

However, while the acquisition of such investments has increased banks’ exposure to credit risk, it does not imply that the headline measure of total social financing growth fails to capture the full extent of credit expansion to households and non-financial enterprises. “Shadow” lending by non-bank financial intermediaries is already covered by this measure. The increase in bank investments in such intermediaries, therefore, represents previous shadow lending being transferred onto banks’ balance sheets, rather than an unrecorded new credit.

The rise in holdings of debt receivables appears to account for most but not all of the rise in bank credit to the financial sector. The FT article stated that total debt receivables grew by 63% to RMB 14 trillion last year, implying an increase of RMB 5.4 trillion. Bank credit to other financial enterprises, however, expanded by RMB 6.4 trillion during 2015.

It is likely that official efforts to support the stock market have also contributed to the rise in bank credit to the financial sector over the past year. More recently, banks may have been lending to finance speculation in bond and commodity markets.

To summarise,

1)    Credit expansion to households and non-financial enterprises is moderate by the standards of recent years. The total social financing measure captures “shadow” lending, including lending by banks channelled through “debt receivables”.
2)    Total bank credit growth has been boosted by fiscal expansion and, probably, the local government debt swap programme (assuming that part of the money raised by new bond issuance has yet to be used to repay previous debt).
3)    It has also been boosted by the transfer of shadow system lending onto banks’ balance sheets. This arguably makes explicit an existing credit risk, rather than creating a new one.

Recent credit developments, therefore, are nuanced and the simplistic claim that a generalised boom is in full swing and will inevitably lead to a bust should be discounted.

The forecasting approach here uses narrow money trends to assess economic prospects. Six-month growth of real (i.e. inflation-adjusted) narrow money, as measured by “true” M1*, rose strongly from mid-2015 into January 2016 but fell back in February / March – second chart. The earlier strength suggests a recovery in economic growth through the late summer, at least. Narrow money trends would need to weaken significantly further to warrant a shift towards pessimism.


*”True” M1 = currency in circulation plus demand / temporary deposits of households and corporations. The official M1 measure excludes household deposits.