China’s Central Bank Policy Raises Doubts

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by Viraj Shah
The Chinese economy grew at the slowest rate in the past 26 years in 2016.The economy grew at the rate of 6.7% in 2016 and moved on to 6.8% by the fourth quarter. Hours after the National Economic Data was presented for the 2nd largest economy of the world, the People’s Bank of China took an unusual step of injecting more money in the market ahead of the Chinese New Year festivities. The step will result in more debt.

In a National Bureau of Statistics press conference, Commissioner Ning Jizhe stated that the debt worry is unnecessary. However, the real estate bubble coupled with massive corporate debt could be posing problems for the country. Soon after the economic data was released, the central bank announced temporary relief for the banks. The People’s Bank of China did not reveal the details but mentioned that it would use market mechanism for 28 days to inject more money into the system.
World economists take China’s numbers with a grain of salt because of the country’s secretive policies. The National Economic Data by China is unlikely to be manipulated this year as growth looks genuine (per official claims). The biggest cause of concern here is China’s debt, which is now 2.4 times its GDP and increased by 16% in 2016 alone. Increased consumer spending is likely the only long-term solution to the Chinese problem as the export driven economy is not showing great results.

Is the move unusual by the central bank?
In times of consistent economic growth, easing up regulations and injecting more money in the markets appears counterintuitive. But with a high-level of non-performing loans (NPLs), banks need a bailout. Conservative official estimates suggest that Chinese banks have 2% loans outstanding. As banks extended credit optimistically, a high number of NPLs have become a major issue for the country’s banking system. Fitch and Credit Lyonnais Securities Asia predict a 15-20% outstanding loan figure for China, ten times as high as the official figures. China is only behind Greece and Italy in NPL loan percentage.

The Chinese stock market shows signs of awareness of NPL problem of the banks. Consequently, bank shares, which were traded at 20% premium, are now traded at 15 to 25% discount from the book value.
Is it all gloom and doom?
Certainly not, the Chinese economic structure is built differently from the US. The savings rate is higher in China and the government backs the banking infrastructure. China also has a closed capital account system in place because of which citizens are encouraged to keep their money within the Chinese banking ecosystem.
With a strong banking system in place, the only trouble to the Chinese economy is real estate. The price rise in the real estate sector is significant. If prices drop, the percentage of NLPs will increase manifold. Additionally, bailing out the banks from the crisis will cause a significant setback to the country as the amount may rise to $4 trillion or 35% of the GDP. A similar bailout in 1999 costed up to 28% of the GDP.
Chinese authorities claim that their GDP numbers are not manipulated. Banks extended $1.8 trillion in loans. This helped in keeping up with the target growth figure of the government (between 6.5 to 7%), coupled with a lenient monetary policy. This year, as geopolitical uncertainties grow and the US-China trade war seems possible, the country will have to bring fresh loans to the economy amounting to $2.7 trillion, only to get a stable 6.5% growth rate. Government’s bet to maintain economic stability will rests on extending credit and moving with an easier monetary policy. Although, it also needs to maintain real estate prices in check to deflate the bubble before it bursts.

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