'Addiction to debt' to fund local growth could spell trouble ahead

China's enormous injection of credit in the first four months of the year has failed to stoke desired growth, triggering concerns that the cash bonanza might not flow into the real economy, but into the shadow banking system instead.

Data released by the central bank last Friday showed total social financing, including all loans, bond issuance and stock sales hit 1.75 trillion yuan ($284 billion) in April.

Though the figure was lower than March's 2.54 trillion yuan, it was still higher than the market forecast of 1.5 trillion yuan.

April's growth made total social financing in the first four months worth 7.91 trillion yuan, up by more than 3 trillion yuan from the same period last year, the central bank said.

"The credit system, like a machine, has been running idle," said Xiang Songzuo, chief economist of Agricultural Bank of China, at a recent conference.

"But the internal cycling of the credit system are growing ever larger and faster."

China's M2, or broad money supply, had grown 16.1 percent by the end of April to hit 103.26 trillion yuan, well above the official target of 13 percent growth rate.

M2 stood at 199 percent of GDP, compared to the US ratio of 60 percent in 2009.

But the rising cash has failed to produce corresponding economic growth rate.

China's GDP growth eased to 7.7 percent on a year-to-year basis in the first quarter, down from 7.9 percent in the fourth quarter of 2012 and lower than many economists forecast.

Behind the overflowing liquidity is the fact China's manufacturers - the pillar of the economy - are reluctant to borrow and step up capital spending given persistent overcapacity and an uncertain growth outlook.

China's purchasing managers' index, a main gauge of the activity in the manufacturing sector, in April declined to 50.6 from 50.9 in March.

Economists worry that instead of flowing into the real economy, where it could be translated into genuine growth and productivity improvement, much of the new money has flowed instead into certain sectors such as real estate.

Their worries are justified.

In the first quarter, lending to households accounted for 35.3 percent of the 2.76 trillion yuan in new loans.

Housing mortgages take up an overwhelming share of the lending to households.

In the first quarter, real estate investment expanded 20.2 percent from a year earlier, while revenues from property sales rose 61.3 percent.

April's average new home prices in 100 cities rose 1 percent over the previous month, threatening to thaw the central government's efforts at reining in skyrocketing house prices.

Zhao Xijun, deputy dean of the School of Finance at Renmin University of China, said special attention should be paid to whether massive money is flowing into a few sectors, pushing up prices in these sectors.

Overheating in certain sectors can easily happen, but inflation of the overall economy can be avoided if macroeconomic policies are flexible enough, said Zhao.

Another major concern is that new money is being used by debt-laden local governments to repay existing loans.

"Local governments face difficulties in getting bank loans, so they have turned to short-term shadow financing," Xu Hongcai, senior economist at China Center for International Economic Exchange, told Reuters.

The possibility is partly backed by a surge in trust and entrusted loans, funding channels that are believed to be favored by many local governments.

Trust loans in the first quarter grew 360 percent year-on-year to 823 billion yuan, and entrusted loans posted sequential growth of 86.3 percent to 523.5 billion yuan, according to the PBOC.

Alerted by bank exposure to local government financing vehicles, the China Banking Regulatory Commission last week ordered banks to stop extending new loans to these vehicles this year.

But traditional banks have already been closed to theses kinds of vehicles for a while, and local governments have turned to trust companies for financing, added Zhang Yugui, dean of the College of International Finance and Commerce at Shanghai International Studies University.

However, the size of local financial vehicles is still growing, and repayment pressure is mounting.

Former finance minister Xiang Huaicheng told a conference in April that local governments may have more than 20 trillion yuan of debt, almost double the figure given in a 2011 report by the National Audit Office.

A report by CLSA Asia, one of the region's top brokerages for research and sales, has estimated China's local government debt to be 18 trillion yuan, or 35 percent of the nation' GDP.

Other kinds of debt, including central government bonds, corporate debt and household debt, reached 205 percent of the nation's GDP.

"China is addicted to debt to fuel growth, and this is obvious with the outrageous credit growth in the first quarter," the report said.

A total of 3.5 trillion yuan worth of bank loans are maturing over the next three years, or 37.5 percent of the outstanding level at the end of 2012, China Business News quoted Shang Fulin, chairman of the CBRC, as saying.

"Local government financial vehicles' loans are posing a systemic risk to the financial system. The risks could be amplified as various financial institutions have stakes in them," said Zhang.

But Zhao said the cash chain could be sustained, as long as liquidity in the market is ample, adding that various financial institutions such as trusts, brokerages and insurance companies are willing to buy bank assets, which is different from Europe where banks' assets are difficult to sell.

The credit surge and disappointing GDP growth could be partly attributed to the growth in China's economy, which demands huge levels of credit, according to Zhao.

"A few years ago, when China's GDP was 30 trillion yuan, you just needed to generate 3 trillion yuan to achieve a 10 percent growth rate.

"Now China's GDP has grown to over 50 trillion yuan, and you need 5 trillion yuan to realize a 10 percent target," he said.

zhengyangpeng@chinadaily.com.cn

(China Daily 05/14/2013 page17)