China's bank chief warns of a 'sharp correction'

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China's bank chief warns of a 'sharp correction'

By Ambrose Evans-Pritchard
Updated

China's central bank has warned in the clearest language to date that extreme credit creation and trouble in the shadow banking system could lead to a full-blown financial crisis.

Zhou Xiaochuan, the governor of the People's Bank (PBOC), spoke of "fierce market reactions" and possibly a Minsky Moment, the tipping point when credit cycles break and euphoric booms collapse under their own weight.

It had long been assumed that this particular form of crisis cannot happen in a state-run financial system where the banks are under Communist Party control.

Mr Zhou told China Daily that asset speculation and property bubbles could pose a "systemic financial risk", made worse by the plethora of wealth management products, trusts, and off-books lending.

PBoC governor Zhou Xiaochuan, left, spoke of "fierce market reactions".

PBoC governor Zhou Xiaochuan, left, spoke of "fierce market reactions". Credit: AP

He warned that corporate debt had reached disturbingly high levels and that local governments were using tricks to evade credit curbs.

"If there is too much pro-cyclical stimulus in an economy, fluctuations will be hugely amplified. Too much exuberance when things are going well causes tensions to build up. That could lead to a sharp correction, and eventually lead to a so-called Minsky Moment. That's what we must really guard against," he said.

China's lending boom since the downturn in early 2015 is comparable to the massive stimulus after the Lehman crisis.

Non-financial debt has galloped up to 300 per cent of gross domestic product - uncharted territory for a big developing economy.

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China's lending boom since the downturn in early 2015 is comparable to the massive stimulus after the Lehman crisis.

China's lending boom since the downturn in early 2015 is comparable to the massive stimulus after the Lehman crisis. Credit: Bloomberg

The International Monetary Fund says debts in the shadow banking system grew by 27 per cent last year.

Less widely known is that the "augmented" budget deficit - including local government spending and the deficits of quasi-state entities - has jumped to 13 per cent of GDP. This is an astonishing level of fiscal stimulus at this stage of the economic cycle. It was around 6 per cent in 2010.

China's hardline banking regulator, Guo Shuqing, right, with Zhou, began cracking down on shadow credit in February.

China's hardline banking regulator, Guo Shuqing, right, with Zhou, began cracking down on shadow credit in February.Credit: AP

The extra spending has turbo-charged the economy and lifted growth to 6.7 per cent, a figure endorsed this time even by private economists.

The boom has allowed President Xi Jinping to bask in glory at the 19th Congress of the Communist Party this week and establish an iron grip over the Standing Committee, but at the cost of greater trouble ahead.

China's economic boom has allowed President Xi Jinping to bask in glory at the 19th Congress of the Communist Party this week.

China's economic boom has allowed President Xi Jinping to bask in glory at the 19th Congress of the Communist Party this week.Credit: AP

Too much exuberance when things are going well causes tensions to build up. That could lead to a sharp correction, and eventually lead to a so-called Minsky Moment.

Zhou Xiaochuan, the governor of the People's Bank (PBOC)

George Magnus, from Oxford University's China Centre, says state control over the banking system means that bad debts can be swept under the carpet for a long time but that does not in itself avert a potential crunch.

"The problems on the funding side are much more pressing, and they won't wait," he said.

The IMF warned in its Global Financial Stability Report that the smaller and medium-size banks rely on short-term funding to cover 34 per cent of their total lending, and most of this is on maturities of three months or less.

This exposes them to a "funding shock" if conditions suddenly tighten, forcing them to sell assets into an illiquid market at fire-sale prices.

This is what happened to Northern Rock, Lehman Brothers, and AIG in the global financial crisis when the wholesale capital markets seized up.

The PBOC has been tapping the monetary brakes for several months.

China's hardline banking regulator, Guo Shuqing, began cracking down on shadow credit in February, greatly reducing the pace of loan growth. This has already cooled the housing market but the full impact on the economy will not be felt until next year.

The problem with the assault on shadow banking is that private companies rely on this form of credit, while the state-owned behemoths or "SOEs" gobble up most of the available loans from the "big five" state banks.

"There is little evidence yet of financial distress but what we are hearing is that a lot of small and medium-sized firms are starved of credit, or have to pay extremely high rates," Magnus said.

The risk for China is that inflation in the US will snap back and prompt the Federal Reserve to raise rates abruptly. That would lift borrowing costs across the world and "stress test" debtors in China. It would also drive up the dollar.

The PBOC would then find itself trapped by the "Impossible Trinity", forced to pick its poison: either follow the Fed with rate rises, or risk a run on the yuan.

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For now, President Xi projects calm. The plan to double the size of the economy from 2010 to 2020 will be achieved, attaining the Confucian goal of "a moderately prosperous society".

Telegraph, London

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