Bank of China Orders Slowdown in New Loans

As widely reported today, the Bank of China ordered its credit officials to slow the pace of new yuan loans due to overly fast lending growth in January. Concerns over an impending slowdown in bank lending, which has been weighing on global stock market indices for the past few weeks (not just in China), contributed to a 2.9% decline in the Shanghai stock index on Wednesday. A data point cited by the Wall Street Journal (“Bank of China to Take Steps to Rein In Loans”) suggests that new loans in the first week of the year grew by a staggering 600 billion yuan ($88 billion) vs. new loans of 379.8 billion yuan in all of December.

Given the multitude of contrary indicators coming out of China over the last few weeks, I thought it helpful to summarize the most salient points:

- Both Chinese Premier Wen Jiabao and Wang Shi, Chairman of China Vanke (China’s largest property developer) have recently warned about the rampant level of housing activity in many of China’s largest cities. While carefully avoiding the use of the word “bubble”, both suggested that the current pace of building is not healthy or sustainable.

- Several studies have indicated that a large percentage of the 4 trillion yuan stimulus money (perhaps up to a third) has been directed into real estate and stock market speculation. As noted in my December 18th post, overbuilding appears to be plaguing many large cities, including Ordos, which remains virtually uninhabited despite the capacity to inhabit over 1 million people (A Must See Video on Ordos). Regional mayors have encouraged excessive building to meet aggressive growth targets - as suggested in the video "who wants to be the mayor who couldn't deliver 8% GDP growth".

- China’s regulators have quietly initiated the first stages of a tightening program, with the reserve requirement for big banks raised by 50 bps to 16% (starting on January 18th). According to estimates by Xing Ziqiang, an economist in Beijing at China International Capital Corp, the increase will remove 300 billion yuan of liquidity from the market ("China Raises Banks' Reserve Requirements to Cool Economy"). While modest relative to the China’s total GDP (~34 trillion yuan in 2009), the move is highly symbolic and indicates that further tightening is likely. In a similar vein, China’s central bank slightly increased the interest rate on its one-year bill by 8 basis points to 1.84 percent, further draining liquidity from the system.

- With the flood of new bank lending that occurred in 2009 (7.37 trillion yuan in the first six months and 9.2 trillion through November), the China Banking Regulatory Commission is rumored to have encouraged the nation’s largest banks to bolster their capital positions. China Construction Bank kicked off the fund raising, selling 20 billion yuan of subordinated bonds in December. According to a recent article (“China's Open Loan Spigot Augurs Ills”), China’s banks could be compelled to raise between 300 and 500 trillion yuan in 2010 to help cushion them from future bad debts.

While fairly benign when evaluated individually, the statements/actions are far more troubling when considered in totality. This fear is certainly validated by the market, which continues to sell off with the announcement of each tightening measure by Chinese regulators. Perhaps the biggest takeaway should be the impact on the US indices once Bernake and Co. decides to take away the punch bowl. If China, which is structurally and financially much healthier than the US, sells off at the whiff of a potential clampdown on bank lending, imagine how the S&P will react when the Fed ends its myriad of quantitative easing programs (and forget about actually starting to raise interest rates!).

It is also probably worth noting that while the US equity markets continue to hit new 52-week highs, the Shanghai Composite Index remains more than 9% off its August peaks. Could this be a harbinger of things to come in the US? At this juncture it is tough to say, particularly with the flood of new money hitting the market, but the recent spike in volatility is certainly disconcerting.

Although I hate to opine on the daily movements of the stock market, I think yesterday’s swoon can be partly attributable to the diminished prospect of a second stimulus package as Republicans increase their clout in Congress. As I have advocated in prior posts, support for the market is primarily being driven by an accommodative Fed and the prospect of continued fiscal support (no matter how inefficient and wasteful both may prove to be). Anything that suggests otherwise (i.e. Brown’s victory in Massachusetts, expiration of the Fed’s $1.25 trillion MBS buying program, the impending confirmation of Bernake, expiration of the homebuilder tax credit in April, etc.) will continue to weigh on the market.