Beijing sends clear message to banks to slow credit creation
The central bank has eased the liquidity squeeze in money markets but with conditions as investors downgrade their expectations for growth
China's central bank eased the liquidity squeeze in mainland money markets yesterday, but only after it made sure the financial system had got the message: credit creation must slow.
As the first chart below shows, Fitch Ratings calculates that in the first three months of this year China's financial system created 7.5 trillion yuan (HK$9.4 trillion) of new credit.
That's more new credit than China created in the whole of 2007 at the height of its Olympic investment boom. As a result, the total amount of outstanding credit in the Chinese economy has climbed to around 200 per cent of gross domestic product, a ratio that has prompted unwelcome comparisons with the United States ahead of the subprime crisis.
The effect of the central bank's signal was dramatic. Although overnight interbank rates dropped to 6.6 per cent from as high as 25 per cent last Thursday, the plunge in Chinese stock prices accelerated.
Accepting that credit will be tighter in the second half of the year, investors downgraded their expectations of economic growth and concluded that the earnings prospects for Chinese companies are looking bleak.
Worse, with credit conditions tightening, they figured that China's banks will no longer be able simply to roll over loans to troubled borrowers, and that some of the country's smaller institutions could soon see a rise in their non-performing loan levels.
In response, investors bailed out of Chinese stocks, pushing the CSI 300 index of the mainland's biggest listed companies down by 6.3 per cent to leave the benchmark almost 18 per cent below its level just four weeks ago.
The Hong Kong-listed shares of mainland companies also suffered, with the H-share index tumbling 3.2 per cent, to leave the benchmark's constituent stocks trading below the estimated book value of their assets for this year - not far off their valuation trough in the depths of the financial crisis.
Yet despite the panic that has gripped financial markets for the last week or so, there are some reasons to believe that for international investors at least, the picture is not quite as black as the sell-off implies.
The week before last Monitor argued that investors were over-reacting to forecasts that the US Federal Reserve would soon begin "tapering" its programme of quantitative easing.
Since then Fed chief Ben Bernanke has said openly that he hopes to begin scaling back his asset purchases soon, terminating them entirely by the middle of next year.
In reaction, markets went into spasms, with investors selling off any and all assets perceived as risky.
Yet despite the panic, tapering may be further off than investors think.
The key indicator affecting the Fed's decision is the US unemployment rate. Bernanke and his colleagues are hoping that as the US recovery gathers steam, unemployment will fall, allowing them to wind down quantitative easing.
But even if growth does pick up, the unemployment rate may not fall. To count as unemployed, you have to be looking for work. However, the US downturn has been so deep that many people have stopped trying to find jobs, dropping out of the work force - and out of the unemployment statistics.
The second chart gives a more accurate picture of the health of the US labour market. It shows the percentage of the working age population actually in employment - a proportion which remains close to 30-year lows.
As the recovery picks up, more of those who have dropped out of the work force will begin looking for jobs again, which means they will be added to the unemployment numbers.
As a result, a recovering economy could well drive an increase in the unemployment rate; an increase which would delay Bernanke's plans for winding down quantitative easing and lend unlooked-for support to ailing asset markets.