We hate sounding like a broken record but a lower flow of new credit in the economy generally means lower GDP growth. Downside risks to growth are even greater when growth is mainly fuelled by an excess of credit, and hence, of debt and not stronger investment.
Debt-based growth is extremely vulnerable to any decline in the flow of new credit. This is exactly what we are experiencing.
The disappointing economic data we have seen in previous months are the direct consequence of negative global credit impulse in 2017, driven by China’s deleveraging process and, to a lesser extent, by the Brexit effect on the UK. Looking at the most recent credit data, the main area of strength at the global level is China. The country roughly represents 1/3 of global growth impulse.
The United States is struggling with a negative credit impulse, resulting from the normalisation of monetary policy, and the euro area is facing a sluggish trend with credit impulse reaching only 0.2% of GDP, moving lower due to downwards revision of GDP. The rise in the global credit impulse at the beginning of 2018 to 5.3% of GDP was due largely to China’s stimulus policy, which has been triggered to offset the impact of trade war. Overall, global credit impulse remains quite weak compared to its previous 2016 peak.
We expect China's credit impulse to slightly increase in coming quarters, as indicated by the sharp jump in YoY loans to non-banking financial institutions since past May. September data indicate it has increased by a stunning 58% compared to September 2017. However, the impulse should be more limited than in previous stimulus period. We used to be sceptical when we hear that “this time is different” but, for once, this time is really different for China, for three main reasons:
1. China will certainly be reluctant to open the credit taps too much, which could ruin its efforts to cut back on shadow banking.
2. China’s economy is less dependent on exports and, thus, more resilient to trade war than years ago. Exports account for only 18% of China’s GDP, compared with nearly 35% in 2007. China’s economic transformation pushes for the implementation of a fine-tuning policy rather than another 2009-style stimulus.
3. In previous China credit impulse peaks in 2009, 2014 and 2016, monetary policy was still very accommodative at the global level, which has certainly increased the net positive effect of the Chinese stimulus.
As a consequence, in our view, one of the top downside risks to growth is not linked to political risk or trade war but to the current divergence of monetary policy between developed countries and China that will limit the positive impulse on global growth from China stimulus. In the best-case scenario, China will be able to support its economy but the virtuous effect of China stimulus on emerging countries and at the global level may be much more limited.
Weak global credit impulse is not yet a new signal confirming the risk of global recession. It would be rather a bold call at this stage. We need more time to assess the exact magnitude and the real impact of China’s stimulus policy, but we can at least safely state that low credit impulse suggests we are moving inexorably into slowdown and we are dangerously approaching the end of the business cycle which started in 2009, almost 10 years ago.