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Survey Suggests China May Finally Be Getting the Message on Debt

By Richard Silk | The Wall Street Journal | June 23, 2014

Analysts long have worried that China’s economy relies too heavily on debt-fueled investment. With a slowdown in the air, companies seem to be getting the message at last: Evidence from one survey suggests both borrowing and investment are at their lowest levels in years.

Only 19% of companies reported accessing credit during the second quarter of the year, down from 30% a year ago, according to the China Beige Book, a private-sector polling organization. That’s despite a drop in the average interest rate on new loans.

Just half of companies increased investment, the lowest figure in the two and a half years the survey has been running. Given that many industries in China suffer from rampant excess capacity — a legacy of sunny predictions about future demand that never materialized — firms may be acting rationally here.

But investment – in manufacturing capacity, infrastructure and an immense building boom – has been the chief engine of Chinese growth for a decade, and dialing down capital spending is likely to have far-reaching effects on the economy. The Beige Book provided little evidence that other sectors, like retail, are stepping in to fill the gap, although the official statistics on retail sales have been more upbeat.

“Overinvestment has been an addiction and withdrawal symptoms will not be pretty,” the Beige Book report said.

According to the official statistics, lending in China continues apace. Banks made a net 870.8 billion yuan ($141.5 billion) of new loans in May. Shadow lending brings the total up to 1.44 trillion yuan.

But if the Beige Book is to be believed, an overwhelming majority of that money is going to a privileged set of established borrowers. Only 1% of bankers in the survey said new clients represented more than 30% of their business, compared with 17% just three months ago.

In a healthy financial system, lower interest rates should quickly lead to more borrowing. Central banks use the interest rate as their main tool to control the growth of the economy.

But in China that process seems to be getting tied up in knots. Funding costs for banks have been subdued for most of this year as the authorities responded to an economic slowdown by easing credit conditions — but companies seem not to be taking advantage of the cheap rates.

Interest rates in the “shadow banking” system – a constellation of lightly regulated lenders serving borrowers who have trouble accessing bank credit – also dropped below the rate on bank loans across China for the first time. For non-bank loans the average interest rate was 6.31%, according to the Beige Book, down more than two percentage points from the previous quarter. That compares with an average rate of 6.84% on bank loans.

The report’s authors speculate that companies slashed investment so much that shadow lenders were no longer needed, and had to cut the price of loans drastically in response.

That suggests a collapse in loan demand caused the decline in new lending, not the other way around. If the problem were fierce competition for bank credit, you might expect shadow lenders to step in with exorbitantly priced bridging loans, as they have in the past.

“Firms appear to be responding to current economic conditions by both borrowing and spending less,” according to the report.

When the demand for credit slackens, central banks find it much harder to support the economy: Their normal tactic of cutting benchmark interest rates becomes far less effective.

At least China can take solace in the fact that it isn’t the only country facing this quandary: Near-zero interest rates in the U.S., Europe and Japan haven’t been enough to stimulate a surge in corporate investment there, either.

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