China’s central bank announced it has begun to reduce coronavirus-related stimulus early – a decision that may be far more relevant for policy evolution in developed economies than presently perceived. The move is part of Chinese policymakers’ renewed focus on risk control (see related blog on China), which reflects a belief that in order to sustain high quality growth, market discipline must be brought to bear on the weakest parts of the economy, including some state-owned enterprises, local government financing vehicles, and over-leveraged property developers. Indeed, the People’s Bank of China (PBOC) – mindful of the country’s high debt-to-GDP ratio and fast-developing financial markets – places a higher weight on financial stability risks than most central banks, and liquidity is often managed to mitigate the risk of asset price bubbles alongside traditional inflation and exchange-rate-stability objectives.
Policy tightening in China is already being felt domestically in the form of tighter money market liquidity, moderating private credit growth, and reduced government bond issuance. China’s credit impulse, a measure of changes in new public and private credit as a percentage of GDP, which typically marks turning points in economic activity, appears to have peaked (see chart below). We believe it’s likely to decelerate through the remainder of 2021. The central bank is targeting overall credit to grow in line with nominal GDP, implying the credit impulse will fall to around -3.5% of GDP by year-end, from a peak above 9% in the fourth quarter of 2020. All else equal, this may slow China’s economic activity to below-trend levels by late 2022.
New public and private credit issuance in China appears to have peaked
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Source: CEIC, PIMCO as of 31 December 2020.
Tighter liquidity may mildly stress China’s corporate debt and money markets…
Tighter liquidity is likely to lead to stress at the periphery of China’s corporate debt market and, at least for short periods, more volatility at the heart of its money market. While Chinese regulators have adeptly isolated selective corporate debt defaults from the rest of the system, mounting debt incurred during 2020 (rising roughly 25 percentage points to nearly 300% of GDP) risks spillovers.
Second, at the global level, the current tightening in China’s credit impulse will occur amid strong fiscal stimulus and improving mobility in the developed economies. This stands in marked contrast to the backdrop of prior declines in the credit impulse in 2011-12 and 2014-15.