China’s Predicament

Liu Mingkang, head of the China Banking Regulatory Commission (CBRC) said in an interview recently that several Chinese banks had been asked to restrain their lending after proving to have inadequate capital reserves. While the regulators will strive to control credit flows, the broader Chinese imperative to maintain growth at any cost contradicts the ability to preserve loan quality and allocate capital efficiently.

Under the guidance of the central government, bank lending – the dominant form of financing in China – has skyrocketed in the past year to spur growth, fend off the effects of slower global trade and thereby maintain social order. Amid the loan boom, Chinese authorities have at times sought to restrain banks, fearing a massive build up of bad loans.

In February, April, July and October 2009, Beijing restrained the banks, only to see lending spike again in March, June and September 2009 – and now again in January 2010. Essentially, Beijing is caught in a cycle of speeding up and slowing down credit expansion. With each deceleration, China’s loan-dependent businesses, mostly state-owned and state-controlled, cry out in pain, resulting in another acceleration to make sure they do not grind to a halt.

2010 is expected to be another year of high lending with Beijing projecting 7.5 trillion yuan in new loans – a smaller sum than the 9.6 trillion yuan lent in 2009, but indicative of a glut of credit consumption.

In order to achieve even a mild reduction in lending in 2010, the Chinese authorities know they will have to take some serious actions to restrict the banks. The demand for banks to increase their capital bases beginning in late 2009 and the raising of reserve ratio requirements on January 12, 2010 forced banks to set more cash aside that would otherwise be lent out. The January 20, 2010 demand that certain commercial banks stop lending for the rest of the month is another such move.

The problem for China is that the entire economy depends on extremely loose lending policies and when credit slows, companies in the critical manufacturing and trade sectors get squeezed. A great many Chinese companies rely on external consumers for their profits but while exports showed growth for the first time in December, they face the usually slow months of January and February, only when spring comes around will it really be clear whether global demand has recovered significantly to support China’s exporters.

Thus, exports are no refuge yet and since Beijing has no intention of knocking the legs out of growth, it will continue shoving credit into the system.