China Paradox: Money, Money Everywhere But Not Enough to Borrow

On November 20, the yield on the Chinese government’s 10-year bond rose to 4.72%, the highest level since January 2005.  That was close to the record of 4.88%, reached in November 2004.  Other Ministry of Finance bonds in October went out at the highest rate since 1996.  Demand equaled supply when usually demand is twice supply. Funding problems are also beginning to be felt downstream, starting with Beijing’s own instrumentalities.  China Development Bank, for instance, postponed its bond offering for two days last month and eventually reduced its size by two-thirds, from 24 billion yuan to 8 billion.  The Export-Import cut the size of its issue as well.  Agricultural Development Bank of China postponed its borrowing indefinitely. While Beijing’s favorite issuers were scrambling to raise cash, corporates were also having a hard time of it.  The gap between corporate and government borrowing rates has been rising at a rate not seen since September 2007, when this metric was first tracked.  Investors last month demanded 182 basis points more for three-year AAA-rated corporate bonds, up 35 basis points in a week.  The average yield on obligations of China’s best-rated corporates hit 6.21% on November 22, the highest rate since 2006, the start of data collection. So November was not a good month for China’s bond market.  Borrowers canceled at least 73.5 billion yuan of offerings.  In October, the figure was 29.8 billion yuan.  In short, larger banks, pension funds, and institutional money managers are losing interest in buying bonds, and the lackluster demand is the result of rising funding costs, which are increasing along with interbank rates.  State media has noticed the surge in rates and is now issuing warnings.  China Securities Journal, referring to corporate obligations in a front-page commentary, talked about a “partial debt crisis to explode.”  That looks to be melodramatic and there may be no explosion, but it is clear the cost of money is now inhibiting investment.  “With such high funding costs, there’s no impetus for companies to expand,”  says Qiu Xinhong of Golden Eagle Asset Management in Guangzhou.  What’s the cause of the increase in interest rates?  “The recent sharp rise in bond yields was mostly due to worsening funding conditions and growing expectations for a tighter monetary policy as Beijing seeks to deleverage the economy,”  said Duan Jihua of Guohai Securities to the Wall Street Journal. This is the same explanation analysts gave for the credit crunch in June.  Then, it was not entirely clear that central government technocrats were trying hard to rein in lending.  The story is the same today. For one thing, if officials at the People’s Bank of China, the central bank, were really attempting to reduce credit, then presumably they would be doing a better job.   social financing, the broad measure of credit, has fallen recently month-on-month, but that’s not the full picture.  Anne Stevenson-Yang, who tracks the Chinese economy for J Capital Research in Beijing, notes that credit in untracked channels has in fact risen.  She estimates that there has been at least a 20% increase in credit this year and puts the real figure closer to 30%.  Yet at the same time credit is exploding, there is an obvious lack of it in the system, as evident from the failed bond offerings in November.  Michael Shaoul of Marketfield Asset Management in New York notes that “the higher yields may reflect a genuine shortage of capital.” How do we explain the paradox of increasing credit and a capital shortage?  Some believe tight credit is the result of the perception that there will be a recovery in growth, but this is an amazingly positive spin considering the independent data showing either a stagnating or deteriorating economy. In all probability, China has reached the exhaustion point that economists had long predicted.  At the same time increasing amounts of credit are needed to rollover maturing debt, credit efficiency has dropped precipitously.  Each yuan of new credit now adds only 17 fen of gross domestic product, a drop from 29 fen last year and 83 fen in 2007.   This fall in efficiency is the result of the country’s credit binge, estimated to amount to $6.6 trillion over the last half decade.  Yet that number, as large as it is, probably understates credit creation because the banks and others have figured out new ways to lend despite increasingly tough regulatory restrictions.  Belatedly, the China Banking Regulatory Commission is proposing rules, to go into effect next February, that close off the more creative lending—and money creation—practices. So why in a time of unprecedented money creation is there is a lack of money in China?  No one has quite figured out the answer to that question, but the fact that both phenomena exist at the same time suggests that the country’s economy, after three decades, has now started a long downhill slide.  On the way down, we are witnessing anomalies like the simultaneous creation of massive amounts of liquidity and the absence of fast growth.  Without fast growth, the demand for money is just beginning to fall. Beijing’s capital-intensive, investment-led model looks like it is now completely out of gas. Follow me on Twitter @GordonGChang

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