China's Curbs on Bank Lending: Implications for the World Economy?

The following is a result of a recent conversation I had with Mauro Ratto, our Head of Emerging Markets, here at Pioneer Investments.

China’s stock market was down very sharply in June, with banks under severe pressure. Are investors right to fear that growth is at risk?

Banks are by far the top-weighted sector group in China, so there’s little chance for the broad market to buck the trend. Indeed the problem is sector-specific at first glance. Policy makers want to curb excess bank lending in an effort to make the industry better managed and more selective. The People’s Bank of China’s attitude suggests that banks are short of money after lending too much and thus deserve punishing interest rates to cover the shortfall. That’s very draconian and so different from the way developed countries regulate their banks.

That may just be a different approach, with few implications for the whole Chinese economy, let alone the global economy. Can we say markets are too concerned?

The reaction may look overdone, but we shouldn’t forget the current uncertain climate. Investor fears over monetary tightening were raised by the prospective end to overly loose policies in the U.S. This sentiment made the U.S. Federal Reserve’s (the “Fed”) gradual time-line for policy normalization (the “tapering” of quantitative easing) appear an abrupt change. China has never embraced overly loose policies but there, too, investors called for some stimulus measures to revive a slowing economy and they are getting tight curbs on bank lending instead.

How important is the change of political leadership in China?

The new leadership, notably the Prime Minister who is in charge of economic policy, has openly talked against things like “stimulus” and “excess”. Property prices are a case in point. Officials are concerned about property-related loans, which are said to fuel a speculative rise in home prices. The way they’re cracking down, however, leads us to believe they want to “prick” the market bubble and trigger a collapse in prices, which may hurt not only banks but also private homeowners.

Is there still an investment case to be made for China, maybe in the longer term?

We believe that Chinese officials are committed to making economic growth more reliant on household spending and consumer goods stocks stand to gain from the change. What surprised us (and most other investors) is the way Chinese officials want to force a change in the banking sector’s practices. Bank loans to businesses account for a disproportionate share of the whole lending industry. However, it would make more sense for the new leadership to follow up on the former Prime Minister’s call for a break-up of the largest banks’ near-monopoly and let them be run like most privately-owned banks in developed as well as in developing countries.

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