China's fears of Japanese-style balance sheet recession trigger fiscal stimulus calls
Lending to the real economy comes in negative for first time in nearly twenty years.
Our briefing on critical economic and financial developments in China as of Friday 16 August, 2024:
The Chinese central bank’s latest round of lacklustre monetary and credit figures has caused major concern amongst domestic observers.
Both renminbi lending and aggregate financing to the real economy posted easing growth for January to July.
In July, renminbi loans to the real economy posted a negative print for the first time in nearly two decades.
Economists say the faltering credit figures are the result of household deleveraging, to repair damage to balance sheets caused by China’s post-Covid property slump.
Calls are almost unanimous for Beijing to launch more accommodating monetary policy and concerted fiscal stimulus, stepping up its debt burden to compensate for household deleveraging.
Lending to real economy negative for first time since 2005
The Chinese central bank’s latest round of lacklustre monetary and credit figures has caused significant alarm amongst economic observers.
Aggregate financing to the real economy was 18.87 trillion yuan for January to July, for a contraction of 3.22 trillion yuan.
New renminbi loans over the same period were 13.53 trillion yuan, for a contraction of 2.54 trillion yuan compared to the same period in 2023.
New renminbi loans in July were 260 billion yuan, 85.9 billion yuan less than the print for the same period last year.
Most worryingly, new renminbi loans to the real economy stood at -76.7 billion yuan in the month of July, for a drop of 113.1 billion yuan compared to the same period last year.
July 2024 is the first month since July 2005 that new renminbi loans have posted negative growth, with many analysts highlighting the role of deleveraging by Chinese households to repair balance sheets damaged by the faltering real estate market.
Chinese economist Ren Zeping (任泽平) further points out both China's M1 money supply growth and new renminbi lending hit record lows in July, despite support from cuts to interest rates by the Chinese central bank and bond issuance by Beijing.
As of the end of July, the M2 money supply was up 6.3% year-on-year (YoY), for an acceleration of 0.1 percentage points compared to June, yet a deceleration of 4.4 percentage points compared to the same period last year.
The M1 money supply contracted -6.6% YoY, for deceleration of 1.6 percentage points compared to the previous month, and 8.9 percentage points compared to the same period last year.
China's M1 money supply growth has continually been in negative territory since April.
Transition from old to new economic drivers cops some of the blame
Wen Bin (温彬), chief economist at China Minsheng Bank, said credit growth in China had been undermined by a difficult shift in the country's economic growth model.
"This financial data largely reflects the pain of the shift from old to new growth drivers," Wen wrote in an online opinion piece.
"As the transition in China's economic structure accelerates and the economy becomes lighter, traditional sources of loan demand that are highly credit intensive, including real estate and local government financing platforms, will gradually undergo adjustment.
"This means credit figures may fail to see growth, or even contract.
"However, credit demand from new economic drivers - such as science and tech innovation, advanced manufacturing and green development - will find it difficult to pick up the slack in the short-term, leading to fluctuations in credit growth."
Others point to household deleveraging, possibility of balance-sheet recession
Other leading economists highlight the role of en masse deleveraging by Chinese households, due to the balance sheet damage endured as a result of the faltering property market.
Zhang Yu (张瑜) a researcher from the International Monetary Research Institute of Renmin University in Beijing, writes that starting from April 2022, China's property market adjustments caused negative growth in household balance sheets.
This prompted Chinese households to begin an "intense deleveraging," which has brought rolling annual growth in consumer loans to their lowest levels since the Global Financial Crisis.
According to Zhang, this household deleveraging also caused an "asset drought", as retail investors followed banks and foreign capital into the Chinese bond market due to weak expectations surrounding property prices.
Jiang Fei (蒋飞), chief macro-economist with Great Wall Securities, said household deleveraging was the reason that renminbi loans to the real economy contracted for the first time in nearly two decades.
Jiang Fei argues that the negative read likely points to China's real economy (meaning non-financial sector) making net repayments, with Chinese households especially active when it comes to deleveraging.
According to Jiang, Chinese households accounted for -210 billion yuan in new renminbi loans for July, as compared to 130 billion yuan for enterprises.
"The household sector is making net repayments of loans, and the enterprise sector is showing a trend of narrowing growth,” Jiang writes.
Prominent Chinese economist Ren Zeping (任泽平) said if left unchecked, this household deleveraging could cause China to endure the same fate as Japan in the 1990s, when it suffered a balance sheet recession.
"At present, household savings are rising significantly, prices for goods and assets are languishing, real interest rates remain high, and aggregate demand is insufficient," Ren wrote.
"This has definite similarities with the balance sheet recession of Japan in the 1990's."
Ren defines a balance sheet recession as conditions where households and enterprises sustain major losses, changing the goal of micro-economic actors from profit maximisation to debt minimisation. This results in them using all of their cash flows to reduce leverage.
"Even though this decision is rational at the micro-level, at the macro-level is can lead to a fallacy of composition dilemma, with financial demand disappearing, loans construction and output falling in a vicious cycle,” Ren writes.
Chinese economists demand active monetary and fiscal policy
The alarming credit data for July has triggered calls across the board for the Chinese central government to implement more active macroeconomic policy in the second half of 2024.
Zhang Yu says the adoption of more forceful fiscal stimulus from Chinese authorities will counteract the shortfall in demand created by household deleveraging.
“In theory, fiscal [policy] should play an even more active role, and government should serve as the borrower of last resort to supplement the gap in credit demand from households and enterprises.
"However, since the start of the year fiscal execution has been slow, with total bond issues in the first half potentially contracting even more than in 2021."
Zhang called for the Chinese government to "increase leverage and accelerate supply-side reforms," as well as "take the lead in providing high-quality assets and expanding credit."
Luo Zhiheng (罗志恒), chief macro-researcher with Yuekai Securities, also called for the Chinese government to serve as the “borrower of last resort,” increasing its debt load to compensate for household deleveraging.
"The July financial data was weak overall, reflecting that at present the recovery of the economy still needs further consolidation," Luo wrote.
"The confidence and expectations of households and enterprises are weak, and there is little willingness to actively expand credit. Growth in financing demand is mainly derived from leveraging by the government."
For this reason, Luo called for "policy to continue to be vigorous and exert greater force," which in practice means "the centre of monetary policy should lean more towards stabilisation of growth."
Jiang Fei said the effectiveness of interest rate cuts in July is already apparent, advancing the argument for more accommodating monetary policy.
"We believe reducing interest rates could play a major role in spurring financial demand," Jiang wrote.
"In July, rates for the 7-day reverse repo, medium-term lending facility and loan prime rates all declined, which helped to further cut financing costs.
“Against a background of low price growth and year-on-year expansion in the decline of home prices, it could be necessary in future to expand the vigour of interest rate cuts."
In addition to action on the monetary policy front, Jiang also highlighted the need for greater action in terms of fiscal policy.
"It is necessary for fiscal policy to be more assertive, driving the issuance and usage of government bonds and expanding fiscal expenditures to form support for domestic demand," Jiang wrote.
Jiang highlighted plans to issue 300 billion yuan in ultra-long treasuries in August, which will provide funds to subsidise capital upgrades and "old-for-new" consumption of durable goods.
Ren Zeping believes the answer is fiscal policy that focuses on "large-scale economic stimulus led by new infrastructure," in areas including artificial intelligence, EV recharging stations and semi-conductor chips.
“This will expand demand in the short-term and create new drivers for the Chinese economy in the long-term,” Ren writes.
“Strong spillover effects have been our successful experience with advance infrastructure arrangements for more than 20 years."
Ren considers the launch of such stimulus plans to be an urgent matter, given the potential for worsening domestic and overseas economic conditions to further undermine growth in the second half.
"In the first half we basically depended on exports and manufacturing sector investment.
“In the second half external demand could fall, putting considerable pressure on stabilising growth."
Ren also called for further tax and fee reductions, to reduce the burden on enterprises and households.