China may slip back into its old habits as growth slows. That could raise debt levels

The construction of a housing and resort district in Liaocheng, China.

Zhang Peng | LightRocket | Getty Images

As China‘s economic growth slows, some analysts say Beijing may return to some of its old policies — like building more infrastructure and easing property controls — and that could add to existing concerns about high levels of debt.

On Monday, the world’s second-largest economy reported growth of 6.2% for the second quarter. Even though official data from China is frequently questioned, the data marked the slowest year-on-year increase for a quarter in at least 27 years.

In addition to slowing global growth and trade tensions with the U.S., China faces many challenges domestically. Beijing has been trying to reduce the country’s reliance on debt for growth, spur consumption and improve the ability of privately-run companies to obtain financing.

But the decline in growth will require more stimulus by the end of the year, analysts predict. And they expect that support, some of which is already happening, will come in the form of more spending on infrastructure, and in turn, increased borrowing.

“In the next six months, monetary policy will play a very limited role,” said Dan Wang, analyst at the Economist Intelligence Unit, noting the central bank will likely only make policy changes targeting specific sectors. “It’s still the fiscal policy that will play a leading role. In terms of the growth driver, it’s still investment, because consumption is very weak this year.”

Retail sales jumped 9.8% in June from a year ago, Monday’s data showed. But the gains were largely driven by a 17.2% surge in auto sales ahead of a shift in emission standards. Fixed asset investment grew a solid 5.8% last month.

‘Shadow banking’ at play

One of Beijing’s frequently touted stimulus measures in the last year has been encouraging banks to lend to privately-owned companies. Those businesses contribute to the majority of growth and employment in the country, but China’s large state-owned banks prefer to work with the less risky companies that are owned by the government.

EIU’s Wang said that many Chinese firms, especially those that are lesser known, still cannot get financing despite data showing that banks are increasing their overall lending to the private sector.

Instead, a survey of more than 3,300 businesses in China from the privately-run China Beige Book showed that in the second quarter, companies reported the highest share of borrowing from the so-called shadow banking sector in the survey’s history.

Shadow lending refers to unregulated financing, typically provided by a non-bank entity, that are subjected to less oversight and present higher risks.

The proportion of non-bank lenders to businesses climbed to 45%, up from a recent low of 21% in the third quarter of 2018, according to the survey.

Non-bank lenders’ share grows to nearly half

Source: China Beige Book

“Every sector reported jumps (in shadow financing),” according to a brief on second-quarter activity from China Beige Book. “A major source of funding this quarter was an old school-type hybrid lender: state-owned non-banks, which represent formalized, state-backed intermediaries channeling credit from traditional banks to those otherwise too risky to formally borrow from them.”

The report noted banks became pickier about who they gave loans to, after lending to more privately-owned enterprises in the first quarter. In general, firms were borrowing more to pay for existing expenses, the report said.

More reliance on infrastructure

At the start of the year, analysts projected that China faced so many economic headwinds that the government’s best choice was to spend on infrastructure.

That expectation remains the same, despite stabilization in China’s economy in the first half of this year.

In a report by ICBC International this week, Chief Economist and Head of Research Cheng Shi, and Senior Economist Qian Zhijun, said that on the fiscal front, measures involving construction bonds and other special government bonds are likely to be added to future policy.

“The role of infrastructure in supporting the economy is expected to be strengthened,” according to a CNBC translation of the Chinese-language report.

Such development projects tend to bring temporary jobs and economic growth to less-developed regions. But it also means issuing more bonds and increasing reliance on debt.

According to data from Wind Information, outstanding local government bonds has increased more than 16-fold in four years — from 1.2 trillion yuan ($174.5 billion) in May 2015 to 19.6 trillion yuan in May 2019.

In the first half of the year, China’s top economic planning body, the National Development and Reform Commission, approved 112 corporate bonds worth 364.72 billion yuan, an increase of 131% from a year ago, spokeswoman Meng Wei said during a press conference Tuesday. Some of the uses for the bonds include the construction of transportation infrastructure, sewage treatment and industrial park development, Meng said in Mandarin.

In June, Chinese authorities also issued a new document encouraging local governments and financial institutions to use special bonds and other financing measures to support major regional development projects.

To be sure, it’s difficult to say whether an expected increase in infrastructure bond issuance will be as great this year as it was a few years ago, said Boris Kan, a vice president and senior credit officer for project and infrastructure finance at Moody’s.

Chinese Premier Li Keqiang announced in March that this year’s economic growth target is between 6% and 6.5%, slower than the 6.6% pace in 2018.

Turning back to property

Some have criticized Beijing for moving too quickly and too harshly in its debt crackdown, contributing to a slowdown in the economy and a bear market — defined as a decline of more than 20% from a one-year high — in the Shanghai composite last year.

“We expect stimulus to escalate around 4Q19, when policy makers would put economic growth as the top priority again,” Larry Hu, chief China economist at Macquarie, said in a note Monday.

“At that time, they would lower interest rate(s) to support the property sector, loosen regulation to boost infra(structure) spending, and roll out measures to stimulate consumer durable goods such as auto and home appliance,” Hu said.

Despite how high property prices have climbed, and China’s recent efforts to restrict developers from fundraising offshore, authorities may find it inevitable to increase support for the real estate market.

EIU’s Wang said that the experience with Beijing’s deleveraging campaign has made local governments more cautious about bond issuance. The manufacturing industry is also under pressure from trade tensions with the U.S.

As a result, she expects that controls on the real estate market will be “significantly relaxed” in the second half of the year, particularly in areas outside major cities such as Beijing and Shanghai.

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