The Never Ending Question: Is China Deleveraging?
A couple of pieces recently argued that China had reached a tipping point that yes, China was in fact deleveraging. Just as a general point I think it is much much too early to declare this is happening much less any type of victory. This is for big picture reasons as well as empirical and cynical reasons. The short version I would argue, as I will show with the data, is that China is not really actively getting worse, maybe slightly worse. More than anything though, they are continuing to build up problems and stretch the capacity of the financial system. I most definitely however, do not think we can say China is getting better.
- Is China debt growth slowing? According to loan data, new RMB loans are up 14% while total social financing is down 14%. This is a confusing picture that leaves people able to interpret it pretty much how they want. So what exactly is happening?
- China is performing a giant twist. Think of pretty much anything we thought we knew about how funds flowed within China and they are trying to change how those funds are flowing. For instance, RMB loans are up strongly while TSF is down strongly because broadly defined “shadow banking” products are being moved onto official bank balance sheets. This is why we see significant declines in one sector and large gains in the other.
- So is debt slowing or growing? Even if we look closer at the broadly defined total social financing, data indicates Chinese debt continues to increase strongly. There are a couple of reasons why. The 14% drop number is the growth of new total social financing. Total social financing, whether it accelerates slowly or decelerates, is still growing rapidly. Put another way, debt is continuing to go up significantly just increasing at a slower rate than before. The stock of total social financing from April 2017 through April 2018 still grew at 11%.
- So is leverage increasing or decreasing? Leverage continue to increase. The numbers are simple. In the first quarter, nominal GDP rose at 10.2% and the stock of total social financing (the slowest growing of the financial indicators) grew at 10.5%. Leverage continues to increase.
- So how good is China doing at deleveraging the corporate sector? China is actively trying to deleverage the corporate sector. I know this goes against the grain of much thinking, but they have not done a very good job. Corporate leverage (via such metrics as debt to equity) has largely levelled off and in some industries declined slightly. New debt in listed and industrial firms has not just fallen but in some sector the total debt load has fallen slightly. Given the weight of debt behind them however, this has had a negligible impact on the leverage ratios.
- So where is the new debt going? Previously, rapid debt growth went to corporations, now debt is flowing enormously to households. According to official data, household debt to household could be above 100%. Bank holding of government debt continues to increase rapidly albeit from a low base a couple years ago. Now however, that government debt held by banks is no longer negligible.
- Why is this building up stress? Debt stress is being widely distributed throughout the Chinese economy. Previously, debt risk was concentrated in the non-financial corporate sector. Now however, that excessive indebtedness is distributed in virtually every sector of the economy. Before, if there was a shock to the corporate sector household and government could step in and help. Now however, there is virtually no sector of the Chinese economy that does not have enormous indebtedness. Distributing it throughout simply lowers the capacity to handle a shock.
- Will leverage continue to increase? Yes, but not quite for the reasons you think. While debt will continue to grow rapidly, it also has to do with nominal GDP slowing dramatically even as real GDP hits Beijing targets. 2017 in China benefited from a jump in the GDP deflator which mirrored the Beijing engineered commodity price surge. As nominal GDP slows with Beijing unable to replicate nearly triple digit commodity price gains, this will make even a constant rate of growth in debt increase the leverage.
- Is this causing stress? Yes. Banks in China are capacity constrained. New loan to new deposit ratios the past few years have averaged about 90%. Add in off balance sheet items and it moves above 100%. Total loan to deposit ratios have hit levels last seen around the time of China’s last banking issues a little more than a decade ago. Reserve levels continue to fall on trend with statistical noise as banks have to borrow and use surplus reserves to meet loan targets.
I was at a conference recently and a speaker put it well saying that has not gotten demonstrably worse in the past year. I think that is a fair assessment with two caveats. First, China is spreading the tension to every corner of the system. Corporate stopped getting worse maybe a little better but households got rapidly worse. The totality of the tension will soon become a much bigger problem. Second, in a year (2017) when nominal GDP jumps almost 4% and the best thing you can say is that things did not continue to get worse needs to be considered a failure. NPLs have already resumed climbing again albeit only slightly. What happens if global growth slows or if commodity prices fall?
It is entirely too presumptuous to assume China is deleveraging after a few months when total debt growth still continues too outpace nominal GDP.