HONG KONG (Reuters Breakingviews) - China’s campaign to cut bad debt is at risk of losing resolve. GDP growth in the first quarter held steady at 6.8 percent, but more substantive indicators like industrial activity and inflation suggest some cooling. The central bank’s hard line on sloppy lending already shows signs of softening.
In most developed economies, central bankers rely on interest rates to encourage or discourage investment. Such tools are unreliable in China, where the financial system is twisted by policy lending and state guarantees. They’re both major factors in the near-doubling of Chinese corporate debt since 2012 to $20 trillion, according to the Bank for International Settlements.
The People’s Bank of China leans heavily on money markets instead. In 2017, for example, robust economic performance buttressed by rising house prices, rallying stocks, and ripping export demand allowed regulators to play hardball with highly indebted companies and speculators. They did so, in part, by driving up funding costs in the interbank market where Chinese banks lend to each other.
Performance that supported aggressive deleveraging last year is unlikely to be repeated. Consumer inflation cooled to 2.1 percent in March, far below the 3 percent target, and talk of a trade war with the United States is hurting sentiment. A first-quarter poll by China Beige Book revealed that most surveyed retailers cut their capital expenditures in the face of shrinking profit margins.
This puts the central bank in a bind. It cannot cut official rates without making a mockery of the debt-reduction campaign. Indeed, it probably needs to keep raising them while helping sustain the pace of business investment. The PBOC has issued over $700 billion of so-called medium-term lending facilities at a nominal rate of 3.3 percent to keep money flowing. That has contributed to the seven-day repo rate – China’s benchmark indicator of liquidity – being on a downward slope since the end of March.
This need not signal an end of efforts to make lending more efficient, best accomplished by structural reform. If bond yields start declining, though, the yuan’s rally against the dollar could stop short right in the middle of contentious talks on imports and exports. It’s a major overhang for China’s economy.
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