New economic data released by China's National Bureau of Statistics on Aug. 13 shows the supply of credit to the Chinese economy expanded by only $44.3 billion in July, the slowest pace in almost six years. To be precise, credit expanded at the slowest pace since October 2008, the month after Lehman Brothers filed for bankruptcy and the month before the Chinese government launched an economic stimulus program that sheltered China's economy from the worst effects of the global financial crisis. That program also locked China into a growth model grounded in the intimate bond between government-led credit expansion and housing and infrastructure construction — one that the Chinese government is now struggling, against time and at the risk of crisis, to escape.
The dramatic and widely unexpected drop in Chinese credit supply in July has raised concerns that the economic "recovery" China seemed poised to make starting in June — when aggregate financing in China hit a whopping $320 billion, which was more than seven times greater than July's figure — has been nipped in the bud. There are also concerns that the coming months will bring even worse news from the world's second-largest economy. These concerns are aggravated by anecdotal reports repeated in mainstream news media saying July's decline is the result of the policy-driven credit tightening by the government and also reflects a drop in Chinese enterprises' demand for new loans. If the latter is the case, it raises important questions about the underlying health and trajectory of China's economy.
Declines in demand for loans are nothing new; they have been cited in the past to explain temporary drops in Chinese credit growth. This time around, however, these declines come against a backdrop of several months of sustained and decidedly not policy-driven declines in home sales, home prices and housing construction activity across major Chinese cities. That context — the inevitable slowdown of China's once frenzied property markets that consumed the lion's share of China's post-2008 lending — adds a new dimension to reports of a slowdown in loan demand.
In short, it raises a question: Is what happened in July merely another turn in the cycle of credit expansion and tightening that has come to characterize China's economic policy of gradually reining in the investment boom of 2009-2010 that has been in place since late 2011? Is it the beginning of something different? In other words, has something in China's underlying economic conditions changed, now forcing a more fundamental shift in the Chinese government's core economic policy?
The answer, as with most things in China, is that it's complicated. At least one reason for the decline in July's credit growth seems to be a dramatic contraction in shadow loan devices such as banker's acceptance notes and trust loans, perhaps emblematic of greater traction in authorities' ongoing efforts to crack down on lending off the balance sheet by banks and informal lending by non-bank entities. This suggests the slowdown is at least partly driven by government policy rather than by a major drop-off in loan demand. Also, it supports expectations, fostered by China's central bank itself, that the government's overall policy on credit has not changed and that with shadow lending now under better control, China's normal credit supply from state-controlled banks will pick back up in August. This expectation for August is supported by the Chinese government's recent moves to relax lending controls on regional banks in an effort to reverse the ongoing downturn in the housing sector.
However, the housing downturn will continue. This much is certain, not only because prices and activity must inevitably come down from the unsustainable heights of recent years, but also because this is what the Chinese government ultimately wants: a housing sector geared toward actual homebuyers rather than credit-fueled speculators. This managed slowdown is only just beginning, but it is accelerating. In July, home sales nationwide fell by 17.9 percent from the year before, the steepest decline in years and the capstone to seven straight months of negative growth.
Home prices are falling, too, albeit less dramatically. In the coming months and years, the Chinese government will work to manage the decline in home prices and construction activity to prevent too dramatic a drop-off — and the financial and fiscal crises this would give rise to — but it will not attempt to revitalize the sector entirely. This represents a subtle structural shift in the Chinese economy. Housing construction and related industries will remain the backbone of China's economy for the foreseeable future, but they will no longer be the growth engines they were between 2009 and 2011.
The slowdown in the housing sector does suggest the knot between credit expansion, housing construction and overall industrial activity, which drove Chinese economic growth after 2009 and that has held the economy more or less together since 2011, is unraveling. But what happened in July does not mark the end of credit, or rather credit expansion and government-led investment as the key drivers of overall economic activity. Barring a highly unlikely rejuvenation of China's export sector, Chinese economic growth will continue to be a function of state-led credit expansion and investment in infrastructure development for many years to come.
This is because China's effort to "rebalance" toward greater dependence on domestic consumption — the process that, China's leaders hope, will eventually ease the overreliance on state-led investment — is still in its infancy. Household consumption remains far too weak to support overall economic growth. With exports unlikely to recover significantly any time soon, and until consumption rises to levels more comparable with advanced industrial economies — a process that could take a decade or more — the Chinese government has little choice but to continue fueling the country's economy through credit and investment.