My Blog

May 18, 2008

SUN 18 MAY

Green on the PBoC Q1 report By Michael Pettis

On Friday Stephen Green of Standard Chartered delighted his fans in the market by putting out a piece called “We strike gold in the Q1 PBoC report” in which he highlights 14 “gold nuggets” he found hidden away in the PBoC report.  There was a lot of interesting stuff in his report and I recommend that people who are interested ask Standard Chartered to send them a copy.

 

I want to highlight three of these “nuggets”.  First, Green notes that the official GDP deflator rose substantially – from 5% year on year in the last two quarters of 2007 to 8.2% in the first quarter of 2008.  There are a lot of problems with the GDP deflator figure, but Green argues that the fact that it jumped so sharply is more evidence that inflation has become a real problem and is spreading through the economy.  Given how sharply it jumped he even wonders why there weren‘t big headlines about this.

 

Second, and this is most interesting to me, lending constraints on commercial banks have been applauded for having slowed the growth in lending by 14% in the first quarter of 2008, compared to the first quarter of 2007.  But these lending constraints do not seem to apply to the policy banks, and their total lending surged by 86% compared to the first quarter of 2007.  Since they comprise 12% of all new lending in Q1 2008, their impact on loan growth is far from negligible – including their loans, total new lending only declined by just under 8%.  I can’t prove this, of course, but I suspect that if we were to include loans from the informal banking sector, loan growth might not have slowed at all in the first quarter. 

 

Remember that one of the strongest tools available to the PBoC to fight domestic overheating and excess demand has been restrictions on loan growth.  I was never very confident that these kinds of measures would work because I assumed that, given the country’s explosive monetary growth, lending constraints would simply push new investment off the banks’ balance sheets.  Green’s “nugget” seems to suggest one way in which this is happening.

 

Third, and perhaps another way in which this is happening, Green notes that foreign currency lending by Chinese banks soared in the first quarter, from $2 billion in Q1 2007 to $48 billion in Q1 2008.  The PBoC claims that 73% of this lending went to support foreign acquisitions by Chinese companies, but Green finds it hard to understand how this can be the case.  He believes a lot of this lending may actually have been used for domestic lending, perhaps to get around RMB lending quotas, and if these were added to the total new RMB loans issued in the first quarter of 2008, including the surge in loans by policy banks, new lending would actually have grown, not declined – if you include loans by policy banks and foreign currency loans, total new lending was 15% higher in the first quarter of 2008 than over the same period last year (and this still ignores the possibility of expansion in the informal banking sector).

 

By the way another “nugget” Green discovers is that average lending rates at the Chinese commercial banks have gone up by only 20 bps from January to March, much less than inflation.  I would argue that this is additional circumstantial evidence that the lending constraints are not biting, or else I would have expected corporations to bid up borrowing rates.  I may be wrong here, because existing banking relationships might make it hard for banks to raise their lending rates too quickly, but it seems to me that if corporations were starving for access to loans one way of rationing this access might have been to raise lending rates.

 

Green also observes a big jump in FX swaps during the first quarter, and suggests this supports his view that a significant portion of foreign currency loans are being spent in China, not for foreign acquisitions.  By the way this may explain some of the remarkable jump in foreign currency reserves at the PBoC during the first quarter.

 

Turning away from Stephen Green’s detective work, the PBoC Q1 report also noted that NPL’s declined from 6.2% at the end of 2007 to 5.8% at the end of the first quarter.  Remember that the NPL ration can improve by a decrease in NPLs or by an increase in total loans.  I don’t remember how much total loans increased during the first quarter (and I am going to the dentist in a few minutes because of a massive toothache that has made my weekend miserable, so I don’t have time to dig up the numbers), but I note that a 6.5% increase in loans would be enough fully to account for the decline in the NPL ratio.