Credit Impulse Update: Is China's deleveraging delayed?

Christopher Dembik

Head of Macro Analysis
Christopher Dembik joined Saxo Bank in 2014 and has been the Head of Macro Analysis since 2016. He focuses on delivering analysis of monetary policies and macroeconomic developments globally as defined by fundamentals, market sentiment and technical analysis.

Since the latter half of 2016, China has gradually moved towards a tightening stance aimed at pushing lower mortgage loans and curbing shadow banking and wealth management products. In early 2017, credit impulse reached its lowest level since 2010 at minus 4.5% of GDP. However, credit restriction is not a one-way stream. In a surprising move on April 17, the Peoples Bank of China cut the reserve ratio in order to ease conditions for businesses and individuals.

Now that contraction in China credit impulse is being felt at the worldwide level (global PMIs are falling apart and early signs of recession are popping up in the US), China is doing what it has always done in case of slowdown: it is stepping in in order to re-stimulate the economy and push credit impulse back in positive territory. China credit impulse is still in contraction, running at minus 2.1% of GDP, but it is slowly rising from its lowest point since 2010 and it might be back above zero sooner than we think if the Chinese authorities consider it is time to further support the economy.

In a highly leveraged economy like China, credit is a key determinant of growth and any credit restriction automatically translates into lower economic activity. Based on recent years, credit impulse and the China Economic Surprise index tend to evolve in the same direction. However, this positive correlation is not always systematic, as is currently the case in the graph below. Such a divergence, if it persists, can be interpreted as a sign of a rise in credit in the non-banking sector, which is not taken into account in our in-house credit impulse indicator.

Among all economic sectors, one of the most vulnerable to tighter credit conditions is the real estate sector. China credit impulse leads house prices by nine months, resulting in lower prices at the national, as we can see below. Real estate deleveraging does not affect all real estate segments equally. The sharpest decline can be noticed in tier 1 cities where prices have dropped into negative territory by percentage change at the beginning of the year whereas house prices in tier two and three cities have only experienced a moderate slowdown. However, this trend is likely to be short-lived since house prices are set for a recovery into 2019 as a consequence of the recent de facto easing by the PBoC and rising credit impulse.

The slowdown in credit monitored by the authorities has been noticeable in banking data over the past years. From mid-2016 until recently, year-on-year loans to non-banking financial institutions were in contraction but the last metric is slightly back in positive territory. It is too early to call for reversal of monetary policy stance in China but, along with the rising credit impulse and the expected recovery in house prices, it seems that deleveraging has been delayed in order to give economy a push. The question that now arises, but that cannot be answered with certainty at this stage, is whether the recent PBoC decision is a single “one-shot” measure or is it the first step of a new easing stance in order to stop an economic slowdown that is certainly underestimated by the market. 

Back to basics, it is safe to say that the leverage process appears to be moderately slowing down. Corporate debt as a % of GDP has decreased from a peak at 167% in Q2 2016 to 162.5% in Q3 2017, mostly as a result of an increasing number of bankruptcies, but public debt and household debt are still piling up at a very steady pace. 

As long as that credit, understood as total social financing (which is the wider measure of credit in the economy since it includes alternative financing), increases faster than nominal GDP growth, there won’t be real deleveraging of the Chinese economy. As shown by the graph below, China is at a crossroads: TSF growth and nominal GDP growth are almost evolving at the same  pace (around 10% YoY). However, considering the ongoing global slowdown and the risk of a US recession in 2019/20, it is unlikely that credit inflow in the economy will go down significantly in the medium term. Once again, China needs to save the global economy, as in 2009/10, at the expense of its own economy and deleveraging.

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