Markets panicked when it emerged that China was to tighten the availability of credit. But the process is expected to be sensibly structured, with the impact to be felt in the long-term as opposed to the short, reports Finbarr Bermingham.
When stories emerged in June that China was to limit the availability of cheap credit in its financial markets, watching the fallout was like witnessing the Chaos Theory unfold before your eyes. If China is the butterfly, then it carries the demand and expectations of economies around the world on its wingspan. One slight flutter was enough to cause mini hurricanes in markets around the world, as panic set in that a credit crunch would ensue.
The government has tried to assert some control over the abundance of liquidity in the market. Credit in China has been growing at 22% a year. Concerns have been rising this year over the explosion of the non-banking lending – or shadow banking – market, which is unregulated and lacks transparency. JP Morgan estimates that the Chinese shadow banking sector is worth anything up to US$6tn.
There are also concerns over the amount of credit in the property market, which the government fears could lead to a bubble similar to the one experienced in the west if left alone. Also a source of concern is wealth management products issued by commercial banks and trust investments, which grew by US$200bn in Q1. We’re now seeing the new administration’s effort to deflate these. But their actions are also part of a wider plan to transform the economy from an investment-based one to a consumption-based one.
In the days and weeks that followed, it was clear that the transformation would be a structured one. The People’s Bank of China (PBC), the central bank, spent days trying to dampen speculation that sweeping reform would take place – it’s rhetoric mitigating and calming.
“The liquidity conditions will remain tighter than banks and markets want, but that’s probably necessary for the longer-term to prevent a more severe correction,” Matthew Strong, partner at insurance broker and risk management company JLT Speciality told GTR at the time. “While they’re keeping a tighter control on liquidity, they’ll make sure there’s a sufficient amount in the system so that growth continues at the required rates. With China it’s always going to be a managed process.
They have far tighter control over these things than other parts of the world, where it has the risk of spiralling out of control far quicker.”
This, it seems, is exactly how things have emerged. In July, the PBC removed the lower limit on interest rates Chinese banks can charge borrowers. It’s another step along the road to market liberalisation, but it’s been described in most quarters as a small one. It has also raised the Shanghai Interbank Offered Rate (Shibor – the rate at which Chinese banks lend to one another) from an annual average of 3% to 3.9%. It’s not a massive shift, and a further indication that Beijing wants any credit tightening to be done on a gradual, sensible basis.
Hit where it hurts
It would be churlish, however, to suggest that China’s change in tack will have no fallout. Over the past decade, China has become the world’s dominant force in overseas projects – particularly in Latin America and Africa, and on the commodities markets, as it bought up the necessary resources to urbanise its population and then support it.
“The withdrawal of capital has always been on the cards,” Rain Newton-Smith, head of emerging markets at Oxford Economics, a research firm, tells GTR. “The sharp movement in the markets in the past month or so has been a bit of an over-reaction to the statements made by China. But it has been disruptive to a certain extent, particularly to emerging markets. It’s clear that countries like Turkey, India, Brazil and South Africa, which have high current account deficits and are reliant on portfolio inflows to finance these, will see an impact on their growth due to China’s shift from an investment to a consumption-based economy.”
The rebalancing of China’s economy is also likely to hit specific industry sectors. In July, Xi Jianping, China’s President, banned the construction of all government buildings for five years, a symbolic move that signalled the end of years of freewheeling, double-digit growth largely fuelled by infrastructure projects. Those in the commodities business, particularly industrial commodities and energy, were huge beneficiaries of this. If anyone’s going to take a hit, they’re surely first in line.
“We’re about to see a shift in the story,” Qinwei Wang, China economist at Capital Economics tells GTR. “Over the past decade if you’re a commodity, steel, copper producer you’ll have been the biggest winner. Over the next decade there’ll be a change –other sectors will come out on top.”
His sentiments are in part echoed by Casper Burgering, senior sector economist, manufacturing and industrial metals, at ABN Amro. Immediately after stories of China’s policy change broke, there was a drop in metals prices, but he attributes this as much to the EU crisis, disappointing PMI data and the strengthening of the dollar as he does to the Chinese situation. Burgering expects the cuts in investment to have an effect, but not immediately. He also feels that the government’s intervention represented a shot across the bows of certain markets.
“There’s uncertainty surrounding the scope of the tightening policies,” he tells GTR. “The market was taken by surprise – the government did it to warn the markets and it helped. It rationalised the markets, they now know the government is serious about its policies and that they can use instruments to intervene when they want to. But it’s unlikely for investment projects to fade immediately. We think the demand from China for metals will grow at least until 2015, but the pace will be slower than we’ve been used to.”
A shift in focus doesn’t mean that Beijing will tie its purse-strings for good. The current five-year plan objectifies growth of around 8%. While this latest development may restrict growth in 2013 to 7%, both Burgering and Wang project it to rebound in 2014. In order to maintain that, China will have to change the mix of its government spend to boost consumption. A large part of this will be centred on improving people’s quality of life.
Already, the government has made positive noises about increasing its investment in green projects in an effort to reduce the massive levels of pollution. Another area expected to receive a capital injection is the welfare state, as Newton-Smith of Oxford Economics explains: “We’ll see a shift in government spending to support rural households. At the moment to get access to social benefits such as healthcare, education and a state pension you have to be an urban resident – it’s called the hukou system. But we’ve seen a phenomenal rate of urbanisation – a lot of citizens are migrants from the countryside who don’t have hukou status. One of the planks of reform is to widen this hukou system.”
There will also be realignment in infrastructure investment. Since 1999, China has ploughed billions of dollars into improving its roads, railways and airports at the expense of social infrastructure. Wang of Capital Economics expects the coming years to bring more investment in things such as hospitals and schools. For those trading in these fields, the shift may reap big dividend.
The long-game is that China experiencing balanced growth of 6 or 7% a year is more sustainable than 10% growth, when that growth is fuelled by incredibly high levels of credit. If it’s managed well (and the early signs are that it will be), the shift in China’s economy should make it more robust, at least for China itself. For those overseas, it may be tougher. All eyes are on the promising East Asian economies of Vietnam, Malaysia and Indonesia but at the moment, there is no country in the world at the right stage of development to take up the lag in demand for commodities such as steel that will stem from China’s rebalancing act.