Another Credit Binge Will Not Cure Economy

BMI View: The recent resurgence in credit aggregates has once again greased China's economic machinery, but it will not last. Not only would another prolonged credit binge further expose China's severe addiction to debt, but we also view the spike in non-traditional lending as a sign of enduring liquidity problems in the economy. As such, we maintain our stance that any third quarter growth bounce will prove fleeting, and that China's structural downturn will come back into focus in 2014.

China's recently-released credit aggregate numbers were truly staggering. Total social financing (TSF, the country's broadest measure of money supply) surged a remarkable 94.1% month-on-month (m-o-m) to CNY1.57trn, shattering the market expectations of CNY950bn by some distance. Put another way, China saw the equivalent of 2.8% of nominal GDP in net new credit injected into the economy in August. Another feature of the latest credit surge has been the dominance of non-traditional financing. Indeed, as the accompanying chart shows, traditional yuan loans as a share of total remain near historical lows.

What Do These Numbers Tell Us?

Casting A Shadow
China - Total Social Financing & CNY Loans

Another Credit Binge Will Not Cure Economy

BMI View: The recent resurgence in credit aggregates has once again greased China's economic machinery, but it will not last. Not only would another prolonged credit binge further expose China's severe addiction to debt, but we also view the spike in non-traditional lending as a sign of enduring liquidity problems in the economy. As such, we maintain our stance that any third quarter growth bounce will prove fleeting, and that China's structural downturn will come back into focus in 2014.

China's recently-released credit aggregate numbers were truly staggering. Total social financing (TSF, the country's broadest measure of money supply) surged a remarkable 94.1% month-on-month (m-o-m) to CNY1.57trn, shattering the market expectations of CNY950bn by some distance. Put another way, China saw the equivalent of 2.8% of nominal GDP in net new credit injected into the economy in August. Another feature of the latest credit surge has been the dominance of non-traditional financing. Indeed, as the accompanying chart shows, traditional yuan loans as a share of total remain near historical lows.

Casting A Shadow
China - Total Social Financing & CNY Loans

What Do These Numbers Tell Us?

The strong credit numbers, coupled with the broad reflationary trend across high-frequency macro data such as purchasing managers' indices, suggest that we are likely to see a relatively strong growth print in Q313. Indeed, we alluded to such a scenario last month when Beijing announced a raft of new stimulus measures ( see ' Our Take On The Latest Stimulus', August 2013). However, we also see a number of other key investor takeaways that cannot be ignored.

Firstly, China remains as addicted as ever to debt as a means to generate economic growth. Total leverage in the economy is on course to hit 220% of GDP in 2013 from just 126% in 2008, underscoring the pace at which debt has been accumulated. With many corporates and local governments still facing serious cash crunches and negative profit outlooks, such aggressive credit expansion is unsustainable.

Secondly, the spike in alternative financing suggests that the positive impact on growth will be limited. As the chart above shows, the 2008-09 credit stimulus was largely directed through formal channels, with Chinese banks extending credit to companies and local governments for infrastructure projects. The opaque nature of credit expansion this time around is more worrisome. In fact, anecdotal evidence suggests that the recent spike in non-traditional lending has been largely driven by China's private sector, which has struggled to get access to bank loans. Such financing is likely to have been used to roll over existing obligations, rather than to build out productive capacity, in our view.

Thirdly, and in line with our view, the spike in informal credit calls into question Beijing's appetite for a serious crackdown on shadow banking. It was only six months ago that the new leadership announced a spate of measures designed to crack down on trust loans financed by 'wealth management products' (securitised retail products), but clearly financial institutions are managing to sidestep such regulation.

2014 Risks To The Downside
China - Real GDP Growth Forecasts, %

Sticking With Bearish 2014 Call

Despite the positive news flow of late, we have seen nothing to convince us that China's economy will witness a sustainable bounce in economic activity, and we continue to hold to the view that real GDP growth will falter once more in 2014. As the accompanying chart shows, while consensus has caught up with our 2013 growth assumption, there remains scope for a further de-rating of China's macro prospects next year. We are forecasting real economic growth of 6.7% versus a consensus mean of 7.4%.

Long-Term Downtrend Still In Play
H-Financials Index

Limited Upside For Stocks

Broadly speaking, we have held a constructive view towards Chinese stocks in H213 and their relative outperformance versus other EM benchmarks, particularly in recent weeks, has been impressive. Still, given recent gains and our broad macro view, we believe that further upside could be limited - particularly for financial stocks, which are likely to feel the brunt of China's debt problems next year. The Hong Kong-listed H-Financials Index remains in a well defined uptrend, but we expect upcoming resistance in the region of 16,500 to hold firm in the coming weeks, possibly signalling the end of the bull-run ( see chart).

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