China dials back on debt

China, the world’s second biggest economy, built up huge amounts of debt after the global financial crisis (GFC) and this acted as a locomotive to drive post-GFC growth while supporting investment markets. 

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Credit growth leapt to an annual pace of over 30 per cent in 2009, providing a huge boost for the economy

"China’s government has acknowledged the earlier pace of credit growth was unsustainable.”

While the pace of growth has slowed since then, it has still outpaced the growth rate of the economy. As a result, the stock of debt has doubled to a little less than 250 per cent of gross domestic product (GDP).   

All good things come to an end

China’s government has acknowledged the earlier pace of credit growth was unsustainable and after undertaking another economic stimulus program in 2015, which pushed credit growth to over 20 per cent, it has now more than halved to 8 per cent.

Such dramatic swings in credit growth will inevitably be important for the economy and markets.

The best way to look at this is how much the growth of credit changes, rather than simply the pace of growth. This is commonly referred to as a “credit impulse” measure. 

Jon Anderson of Emerging Advisors Group calculates a series for China which looks at the changing growth of credit relative to the size of the economy.

It shows a dramatic rebound in growth in 2008, followed by a slowdown that troughed in 2014 before another dramatic rebound and sharp slowing in recent years. 

The current reading puts the credit impulse at its weakest in a decade but with some signs of stabilisation beginning to emerge. However, credit leads the economy by around a year and flags a weakening in momentum for a while yet.

But the impact appears to extend well beyond China’s shores.

Global impact

The China credit impulse series, with a lead of around a year, has correlated reasonably well with the Global Manufacturing Purchasing Managers Index series (PMI) since the GFC period.

In a world where most economies were reducing their debt burden, China’s aggressive leveraging has made it a locomotive for growth. 

The relationship is particularly evident for trading nations such as Germany. The IFO sentiment survey for German industry warns a sharp slowdown in global manufacturing may eventuate if China’s weak credit impulse series is maintained for a period of time.

Fortunately China has undertaken a range of easing measures in recent months, with some recovery underway, but it is still early days.

Given the close link with economic growth trends, it’s not surprising we also find a correlation between the credit impulse and the returns of global equities with a lead of a year.

The moderation in equity returns so far this year is consistent with this trend of a fading credit impulse. 

Slow down

The two largest economies – the United States and China - both have policy settings pointing to a slower economy. I recently wrote about the flattening trend in the US yield curve and the slowdown it flags.

An economic slowdown and weaker investment returns in 2019 look highly likely. But just how much is unclear at this point in time.

The US’s large tax cuts and increased government spending may hold up US growth for longer than expected. And limited further tightening from the US Federal Reserve would point to only a moderate slowdown in growth.

For China, there’s been a sharp weakening in the credit impulse which can’t be ignored. The current policy easing underway may limit the downside but its early days and it will have to be closely monitored to gauge its effect.

Mark Rider is Chief Investment Officer, Wealth at ANZ.  

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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