China’s government is allowing the nation’s overall debt level to grow again as it engages in an aggressive campaign to boost new lending to prevent an economic meltdown amid the trade war with the United States. The change in tactic brushes aside, at least in part, the deleveraging campaign that was one of the economic policy priorities set out by President Xi Jinping over the last three and half years. While Beijing insists it will not embrace massive policy easing to avoid a repeat of the sharp build-up in debt seen after the global financial crisis a decade ago, it is clear that the debt reduction drive has come to an end, at least for now. Banks granted 3.23 trillion yuan (US$477 billion) in new loans in January, while total social financing, which includes bank loans, bond and other financing vehicles, reached a record 4.64 trillion yuan (US$685 billion) last month, an amount equal to 5 per cent of China’s gross domestic output last year. China’s economic policymakers are explicitly encouraging additional debt accumulation with local governments allowed to sell more bonds to finance newly approved infrastructure projects, with the bonds front-loaded to get the money to work sooner. In addition, the People’s Bank of China (PBOC) is helping banks to sell perpetual bonds – bonds with no set maturity – so that lenders can boost their capital levels and lending capacity. Bank of China, one of the big four state-owned banks that is in need of capital, last month issued 40 billion yuan (US$5.91 billion) worth of perpetual bonds. The government’s increasing aggressive lending drive comes in response to the continuing slowdown in the world’s second largest economy, which has been hit by a weaker domestic and external demand amid the US trade war. China set to report slowest economic growth for 28 years Economic growth in 2018 fell to 6.6 per cent, the slowest in 28 years. President Xi Jinping had made the fight against excess gearing a centrepiece of his economic policy, including making it one of the government top three policy priorities as the beginning of last year. But the start of the trade war with the US last summer and the drag it exerted on an economy already slowing from the effects of government efforts to reduce financial risks meant that Beijing has had to sideline its hard-line stance on curbing excess debt. “There’s nothing wrong with trying to stabilise investment [through more lending]. It’s not an evil thing. On the contrary, we must spend more effort on it,” said Wang Yiming, deputy director of the Development Research Centre of the State Council. “The downward pressure [on the economy] remains huge” despite quickened pace of infrastructure project approval and bond issuance in the second half of last year, Wang said. Beijing has already launched a series of supportive measures to boost the economy, such as cutting personal taxes, strengthening investment in infrastructure and encouraging more lending to the private sector by cutting the amount of money that banks must hold in reserve at the central bank four times last year and twice in January. What is China’s latest economic move to offset US trade war? Last month, Bank of China, the country’s fourth-largest lender, sold the first-ever perpetual bond issued by a Chinese bank, while the PBOC set up a new central bank facility to ensure adequate liquidity for banks selling the bonds. This allows certain banks to borrow central bank bills or short term financial notes, using perpetual bonds as collateral. “We believe the two new tools and the expansion of the collateral pool are strongly linked to the support for China’s cash-strapped private sector. In other words, banks will be supported while being obliged to lend for China to stem its rapid deceleration,” said Alicia Garcia Herrero, chief economist for Asia-Pacific at Natixis last week. Beijing has attempted to unwind debt accumulated in its financial system, in particular through the shadow banking system, on which the small and medium-sized companies have relied on for credit. However, most shadow banking activities have been curtailed by moves to reduce risky lending, leaving smaller private business with sharply reduced access to credit. There is no doubt the campaign to reduce debt had started to work as China’s overall debt ratio dropped last year for the first time in the past decade, according to Zhang Xiaojing, a senior researcher at the Chinese Academy of Social Sciences. China’s debt-to-gross domestic product ratio declined by 0.3 percentage point to 241.8 per cent last year compared to 242.1 per cent in 2017, when it rose 2 percentage points from 2016. China eases bond issuance rules in bid to boost economy But China has set stabilisation of economic growth and employment as its new top priority, allowing more debt to accumulate again through bank lending. But it remains to be seen if the central bank’s new facilities will encourage local banks to lend to cash-strapped private sector firms to support longer-term growth, according to Nicholas Zhu, senior analyst for Chinese banks at Moody’s. On Friday, Sun Guofeng, head of the PBOC’s monetary policy department, denied the central bank was engaging in a massive monetary stimulus effort like seen in 2009, attributing the record monthly new loan level in January to targeted government efforts to support the economy and a rush from the banks to increase profits by lending earlier in the year. “The reasonable growth of money supply and aggregated financing was due to the need for [targeted] counter-cyclical adjustments and support for small and private firms has been strengthened,” Sun said. “It’s not a large loosening [of monetary policy] as the macro leverage remains stable.” China’s January loan data included a large increase in short term financing to the private corporate sector, which may indicate that banks remain reluctant to fund longer-term projects which tend to be riskier, Zhu warned. The data shows that lending is starting to move in the right direction in response to the PBOC’s measures, added Zhu. “But we don’t know yet if they will be effective. I believe banks will lend more, but they also need to manage their risks,” said Zhu. “It’s hard to predict volatility going forward. There is a great deal of pressure on them [in terms of credit quality] but we think the pressure is manageable.” China central bank bills swap to aid liquidity of banks’ perpetual bonds Analysts believe the short term risk from China’s slowing economy is greater than the long term risk of more debt. Fitch Ratings said it does not expect China’s deleveraging campaign to be called off completely, as there is still capital constraint at the banks, which remain cautious about lending to the private sector, particularly smaller companies. “When the economy is heading downwards, it is difficult for banks to lend more,” said Xia Le, chief economist for Asia at BBVA Research. “Risks [of defaults and the accumulation of bad debts] are higher for the banks. The [biggest] risk right now isn’t really about the rapid growth of leverage. In my view, the bigger risk is the rapid deceleration of economic growth.”