Chinese alarm bells

Lend, lend, lend! It is not only US and European governments that want banks to extend more credit. China does too. Its weekend move to abandon curbs on bank lending curbs rings two alarm bells. First, it shows that after three interest rate cuts and a reduction in bank reserve requirements, the economic slowdown is more serious than Beijing initially thought. Second, banks are going to have to carry some of the cost for cranking up the engine. Effectively, they are under orders to lend to the credit-starved – in other words, riskier borrowers less likely to repay their loans.

Evidence of a sharp slowdown is increasing, especially in the export-dependant southern coastal provinces. Manufacturing last month contracted by the most since the CLSA PMI survey began in April 2004, marking the third consecutive month of deterioration, and bringing the series to a fresh low. As economic growth falters closer to 8 per cent – the level below which employment levels fall off, potentially creating problems for social stability – Beijing is opening up the spigots.

The government can afford to meet any extra bills: China has both the balance sheet and the need for infrastructure to justify fiscal largesse. The position for the banks is more precarious. As they remain state-controlled, and most bank managers grew up on state-mandated lending, increased lending is unlikely to be a purely commercial choice. Chinese banks never really got to grips with risk pricing. By far the bulk of loans are made at or around the policy rate; riskier borrowers tend to be refused funds altogether. Provisioning costs against bad loans are already creeping higher. Bank of China, one of the big three lenders, reported credit costs of 0.4 per cent of loans in the third quarter, slightly up on the year-ago level. Increasing lending into a downturn seems to be a perfect recipe for jacking that up across the industry.

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