Having fairly often given space to what might be deemed the gloomier outlook for China’s economy (see previous post), it seems only fair to allow the optimists some room. Here on two key issues is the take of the China economists at bankers research Merrill Lynch (a proud member of the Bank of America family), who, as they note, have consistently called for 8 percent GDP growth this year even when all others were dropping their predictions faster than…., er, well, very quickly anyway:
Will slowing loan growth drag down the economy?
Exceptionally high new loans in January and February are definitely not sustainable and headline year-on-year credit growth will fall sooner or later. Some investors told us that they are also worried that the government may impose new restrictions on bill financing soon. Is it possible for us to see a sudden contraction of credit? Could slowing credit growth hamper a recovery in 2H09? Quite a few investors expect a significant setback for China’s GDP growth as they foresee slowing credit growth.
Those worries are overdone, in our view. If China’s growth at mid-year exceeds 10% and the economy becomes overheated again, then yes, the regulators could put the brakes on credit expansion again and bill financing will be hit hard (just like what happened at end-2007). But the economy is in such dire straits that it is almost impossible for China to become overheated anytime soon (we are definitely not so bullish despite our 8.0% GDP growth call for 2009). That said, we believe financial regulators may issue some “window guidance” to ask banks to be more cautious on bill financing. But those “window guidance” will just be moral suasions this year, in our view.
Will NPLs balloon?
Will Chinese banks’ NPLs soar on the heels of the country’s stimulus measures and the recent surge in bank loans? Will the economy be dragged down by this credit binge? Are the banks extending so many loans simply because they are pressured by bureaucrats to do national service?
NPLs will surely rise at a faster pace in this downturn, but the RMB4tn package won’t bring down the banking system NPLs to rise, but no comparison to a decade ago. We do expect NPLs to rise much faster amid this economic downturn as thousands of enterprises shut down in the face of plunging exports and slumping home sales. However, NPLs related to bill financing have been close to nil in past years, and Chinese banks are not so mismanaged as to allow bill financing to ruin them. Loans to government-initiated projects in the RMB4.0tn stimulus package are quite safe because those projects are either explicitly or implicitly backed by the central government which could print money if necessary.
One major difference between now and 10 years ago is the governance structure of big Chinese banks. A decade ago, provincial branches of big banks like ICBC and CCB were more under the sway of provincial governments than their headquarters in Beijing. This special structure created a classic public domain problem. All local governments had the incentive to borrow and then to default as much as possible, because gains belonged to them and costs would be shouldered by the whole country (or the central government in Beijing which had to print more money to clean up massive NPLs in those big banks). However, reforms of the banking system in the past decade have consolidated those big banks and made them truly vertically integrated. It is no longer easy for local governments to treat the provincial bank branches as their ATM.
To sum up, NPLs will rise, but the situation is unlikely to be as bad as 10 years ago in the aftermath of the Asian financial crisis and before the restructuring of China’s commercial banking system. We expect this cycle (spanning from 2008 to 2010) to turn at most 1.5% of current outstanding loans (about RMB460bn) into NPLs. We are also quite confident that China’s banking system would not crash as a result of this massive fiscal stimulus measures. The flexibility of China’s economic system, including the banking system, should not be underestimated.