Official data on Thursday showed China’s economy accelerated by 7.9 per cent in the second quarter, far ahead of analysts’ consensus estimates. But just how solid an indicator is that for the global economy, given most of the surge was driven by the government’s extremely loose fiscal policy?
RBC Capital Markets analysts are among those eyeing the potential risks of the record state-bank lending that took place in the last six months (our emphasis):
But it is not clear how long this can be sustained as evidence accumulates that policy stimulus is working quickly, in some cases with problematic side-effects. Easy policy has already contributed to sharp moves in asset prices, with the equity market posting strong gains in recent months and the property market also rebounding. These gains have been fuelled to some extent by speculative activity facilitated by the large increase in bank lending, while this week’s fx reserves data also suggests that capital inflows surged in Q2 as foreign investors hopped on the bandwagon.
This asset price inflation they refer to, by the way, can easily be seen in the moves of the Shanghai Composite since the beginning of the year:
As the analysts go on, the key risk of the lending binge will now be the credibility of the loans made out:
High bank lending is also naturally raising concerns about the quality of many of the loans – NPLs are likely to rise in the medium-term, and there is a good chance that some of the projects now being funded will prove ill-advised and put borrowers under severe pressure. In some cases, these borrowers will, directly or indirectly, be local and regional governments, with the central government likely to eventually be forced to pick up the tab.
To put China’s 2009 lending into context, here’s a useful chart from Standard Chartered:
The clear concern of all this, as the RBC analysts also point out, is the effect on money supply and via that inflation:
Money supply is now growing close to 30% y/y, well above the government’s 17% target and at a 12-year high – combined with recent gains in commodity prices, this clearly represents a major upside risk to inflation in the medium-term. These developments are all the direct result of policy measures aimed at supporting growth.
Standard Chartered tend to agree:
We expect CPI growth to average 0.1% y/y in 2009. We do not think the next six months will see the return of significant global inflation. As we show in Chart 4, according to IMF forecast, global activity levels will remain well below 2007 peaks until 2010. However, we believe that the risk of significant inflationary pressures appearing in China in 2010 — earlier than anywhere else — is now rising.
As for China’s dollar dilemma, the hot inflows into the country due to asset-price inflation are hardly helping its quest for reserve diversification. In fact, the interesting point RBC allude to is that China’s somewhat epic commodity stockpiling in the period may be the direct consequence of trying to minimise the build-up of those dollar reserves — which now surpass $2,000bn — brought on precisely due to those inflows. As they write:
The large increase in China’s fx reserves in Q2 also does nothing to solve Beijing’s dilemma about its USD-holdings. Much of the increase in reserves in Q2 reflected a resumption of hot inflows into China, which further complicates efforts by Beijing to diversify out of USD-denominated assets. The increase in reserves would have been even higher were it not for strong purchases of commodity imports in recent months, a trend which, as we have noted previously, appears to reflect a strategic decision to build stockpiles as an alternative to buying financial assets. This is also likely the main factor behind the decision, announced yesterday, to go ahead with plans to relax restrictions on outbound investment, making it easier for Chinese companies to make foreign acquisitions (with the resources sector likely to remain the key focus).
Related links:
China’s forex reserves pass $2,000bn – FT
China’s fake recovery redux, or who’s laughing now? – FT Alphaville
China’s fake recovery – FT Alphaville
Chinese liquidity – and stocks – go boom – FT Alphaville