Xi wants full control of China’s financial sector

• Xi Jinping’s financial market shake-up means the sector is likely to toe the Party’s line
• Beijing is easing monetary conditions and planning to keep risks down with tighter Party control
• Monetary policy will remain a hybrid quantitative and price system, with the authorities boosting both the quantity of money and credit and lowering interest rates
• Expect more administrative guidance and efforts to cushion bank margins

Beijing boosts broad money growth & lowers lending costs

• Broad money growth has accelerated to its fastest pace in six years as the authorities have been easing policy more aggressively. Enodo uses its comprehensive M3 measure to gauge overall monetary conditions in China
• Three-month annualised rates, a better guide to recent trends, suggest broad money growth is set to accelerate further

• The PBoC has been cutting bank funding rates to spur bank lending to both firms and households, but demand for credit has been muted
• The Q1 2023 banking climate survey offers some hope with loan demand at 78.4, up from 62.2 in Q4 and an average of 66.9 in 2000-22. But the loan approval index remained unchanged

• The PBoC cut banks’ RRR by 25bps, effective Mar 27th, releasing Rmb500bn of liquidity and we expect one or two more cuts this year
• Beijing is keen on lowering funding costs to banks by using RRR cuts as well as helping banks deal with mounting credit losses

• Banks are between a rock and a hard place as net interest margins have shrunk further after Covid hit
• Beijing’s de-risking efforts have also sapped banks’ non-interest income, as off-balance sheet assets have been brought back onto banks’ balance sheets

• Real interest rates have shot up as CPI inflation has eased, while PPI deflation deepened.
• Beijing wants to see lower interest rates, hoping this will lead to a revival in corporate borrowing growth. We expect one or two MLF cuts this year as well. The benchmark LPR rate is priced off the 1-year MLF rate

• The PBoC has also mandated preferential interest rates for micro and small firms and has increasingly used one of its oldest monetary policy tools: relending
• Under its relending facility, it provides banks with funding for loans to certain borrowers at below interbank market rates
• Corporate borrowing growth has picked up speed, but household credit demand remains muted

• Annual mortgage borrowing growth has fallen off a cliff and continued to decelerate in Q1 2023, down to a mere 0.3%
• The authorities have been trying to boost mortgage borrowing growth by mandating banks to lower mortgage rates and increase loan-to-value ratios, as well as providing other administrative incentives

• But with the housing market still in the doldrums households have been reluctant to return
• Q1 survey data shows that expectations for house price inflation as well as investment in housing are now improving
• Structurally, China has scope to boost mortgages as a share of GDP, but by itself this is not a sustainable route to growth

Don’t bet on the Chinese consumer

• To help shield bank interest rate margins, the authorities have been guiding banks to lower deposit rates
  

• But Chinese households are large net savers, so lower bank deposit rates would do more harm to consumer spending than good. This tilts the economy yet again towards credit-fuelled investment, which is unlikely to be more productive than in the past

• Last September China’s biggest banks lowered their benchmark deposit rates across the board for the first time since 2015, following some selective reductions in April
• Beijing has continued to guide banks to lower deposit rates this year
• This does not bode well for China’s interest rate liberalisation process

• Consumer spending rebounded in Q1 as the Chinese were unleashed from lockdown, but Beijing is likely to struggle to engineer a sustainable boost to household consumption
• The tech sector crackdown and the ordeals of SMEs have battered employment; and Xi’s “common prosperity” has hurt household income and wealth 

• The main asset for middle class Chinese families is property. In cities, families hold apartments for capital gains, not rental income as the rental market is underdeveloped
• So they get close to no income from their tangible assets on top of paltry returns from the bulk of their financial assets. These trends are unlikely to reverse decisively any time soon

• The urban depositor survey in Q1 offered a glimpse of hope as both the preference for saving deposits fell and the preference for investment rose
• But both remain close to their all-time high and low respectively. We need to see sustained and bigger changes to get optimistic about the Chinese consumer

• Expectations for house price increases also improved, with more households expecting rising prices
• But for Xi house price inflation is anathema, as he identifies it as the main source of gaping wealth inequality in China. Indeed, he wants property prices to come down and at best stay stable and has no intention of changing tack on this front

Old-style growth is all Xi can muster to steady the ship

• China's official real GDP growth came in at 2.2% (8.8% qoq ar) in Q1, supported by net exports and a rebound in consumer spending
• Real GDP growth is likely to slow in Q2 but remain solid as Beijing's stimulus filters through. The base effect means that the year-on-year growth number Beijing will publish will show faster growth than in Q1

• With consumption likely to be muted after its post-lockdown increase in Q1 and the real estate sector still in the doldrums, Beijing has doubled down on old-style growth to prop up its ailing economy
• Real fixed asset investment is likely to provide a boost to growth through to the end of this year, but this mode of development is close to its expiration date

• Enodo's nowcast points to a quarterly increase of 1.3% in Q2 compared with 2.2% in Q1 and an average growth of 0.8% in 2022
• Enodo's nowcast has been thrown off by the negative/positive shocks of the Covid and post-lockdown changes, so Q2 growth could be somewhat stronger than our nowcast suggests

• Deterioration of PMIs in manufacturing and weak investment activity, especially in the construction sector, further impacted the GDP growth nowcast negatively
• Improving trade dynamics of exports and imports contributed positively to the nowcast

Debt-deflation to plague China’s economy

• Enodo has combined bottom-up analysis of China’s quoted sector loans with a top-down macro evaluation of the returns on credit, to estimate expected loan losses following its post-GFC borrowing binge
• We estimate credit losses at a range of between 26% and 31% of GDP and poised to grow further in 2023

• The three Ds – default, demand deflation and devaluation – are the solution to an excess debt problem, and typically countries resort to a combination of all three
• China’s current pump priming is set to raise its debt burden further. This is not a sustainable mechanism. Beijing needs to boost productivity and consumer spending but it remains unclear how it will do that

Is China uninvestable?

• Beijing’s decisive lurch into “one-man rule” and deteriorating Sino-US relations have reenforced Western investors’ perception that long-term investing in China is imprudent in the context of the Great Decoupling
• But favourable Chinese monetary conditions, both in absolute and relative to the US terms, bode well for A-shares in coming months

• Beijing has fallen back on an old playbook: Stimulus now, worry later. So in the short-term the only thing that could overturn the apple cart is the fraught Sino-US relationship and further US measures to contain China
• For now, short-termist investor optimism is likely to dominate the China debate