On of my favorite China experts is Victor Shih, a political science professor at Northwestern University and an expert on financial and economic policy-making within the Chinese leadership.Yesterday the AsianWall Street Journal published a piece by him called “China's Credit Boom”, which is well worth reading. In case any one has missed it I am reprinting it below.
China's Credit Boom
The rest of the global economy may be experiencing a credit crunch, but not China, where easy credit has fueled a spectacular run-up in real estate prices and stock markets. Despite a cascade of State Council decrees restricting bank lending this year and a high-profile Politburo meeting in November that focused on the risk of inflation, bank lending last month grew by over 800 billion renminbi ($112 billion) -- equivalent to 22% of the total loan quota that Beijing's technocrats meted out to state-owned banks for 2008.
This rate of credit expansion is similar to the rate last seen in the second quarter of last year, when China's economy grew by nearly 12% from a year earlier. And it comes just as the Party is trying to ratchet down inflation, which in January hit 7.1% year-on-year on consumer prices.
Technical factors don't fully explain why the monetary base grew with such fervor in January. The lunar new year holiday took place earlier this year than usual, driving up demand for cash. However, new year cash spending usually means withdrawing one's savings, not borrowing from banks. A severe winter snow storm forced the central government to release tens of billions of renminbi in funds to pay for emergency spending. But this amount would be a blip in the Chinese monetary landscape, which runs into the trillions of renminbi in a given quarter.
More convincingly, major borrowers are pressuring banks to lend out as much of the credit quota as possible. Companies want to take advantage of low real interest rates and lock in cheap cash for the remainder of the year. Although large firms, many of which are powerful state-owned entities, are undoubtedly exerting pressure on banks, State Council loan ceilings precisely seek to minimize the effect of firm pressure by coordinating all banks simultaneously to cut back on lending. However, bankers called the technocrats' bluff and proceeded to lend with gusto. In effect, they are daring Beijing technocrats to enforce the credit ceiling and risk a widespread liquidity shortage in the latter part of the year.
This is an unusual game of chicken. China's major banks, all of which are majority state-owned and run by managers appointed by the Communist Party, are simply ignoring decrees issued by the highest authorities.. In a state-dominated banking system, this is as unexpected as mid-level managers blatantly acting against the wishes of both the CEO and the board of directors. Formally the technocrats have the full backing of the ruling Communist Party and can dismiss any banker at any time. However, senior state bankers do not behave as if they take the threat of removal seriously. They've stared down such threats before, anyway -- in China, elite political discord has often compelled banks to disobey formal decrees.
Politics may be at work here. First, the increasingly vocal National People's Congress, China's rubber-stamp legislature, is slated to open its new session at the beginning of March. Many top technocrats, including central bank governor Zhou Xiaochuan, will receive new appointments. Others will simply be reappointed to their posts. Thus, technocrats may hesitate to enforce loan ceilings because they do not want to anger regional and industrial lobbies represented in the NPC that want easy credit. But although the NPC formally votes to appoint ministers, in reality, their appointments are decided by the Politburo Standing Committee -- the same body that voted to support retrenchment policies in November. Thus, the technocrats should not feel threatened by the NPC, even though the NPC may not prefer retrenchment.
There are plentiful historical precedents for these kinds of politically driven loan surges. In the 1980s and '90s, feuding elite factions cheered their provincial followers to borrow heavily from the banks. Banks, knowing that elite politicians in the Communist Party's Politburo supported loose lending, felt they had little choice but to open the monetary spigot. Likewise, because the technocrats knew that banks were lending due to elite political pressure, they could do little to punish banks. Both the technocrats and the banks served the same master -- the political elite in the Communist Party. This often led to serious inflation trouble until the faction with the most to lose from an economic crisis decided to support senior technocrats and crack down on lending, thus ending loose lending policy and stifling inflation.
Something similar may be happening today. When faced with rising inflation late last year, President Hu Jintao decided to support Premier Wen Jiabao's retrenchment policies. There were signs, however, that not every member of the ruling Politburo Standing Committee agreed with retrenchment policies. Days before the November meeting, for instance, Premier Wen announced on a trip to Singapore that lowering asset prices was a high priority. Yet, the Politburo meeting did not endorse this policy goal, strongly suggesting that some members of the top elite opposed it.
The most likely opponents of strict monetary policies are powerful "princeling" officials -- children of the Communist Party's founders -- who have close connections with economic interests in China's big coastal cities. Some of these interests, which include manufacturers and real estate developers, have suffered from the tight monetary environment. Detecting elite discord on retrenchment policies, bankers are then emboldened to disregard central decrees, betting that their elite supporters would protect them from the wrath of the technocrats.
The Chinese government needs to continue monetary tightening by raising interest rates and the bank's reserve requirements. Furthermore, Messrs. Hu and Wen need to overcome internal opposition and make it clear to bankers that flouting central decrees begets serious consequences, including dismissal. Otherwise, they risk allowing inflation to spiral toward dangerous levels. In the opaque Chinese political system, strong signals, in addition to decrees and laws, continue to be necessary ingredients of credible policies.
Mr. Shih is a professor of political science at Northwestern University and the author of "Factions and Finance in China: Elite Conflict and Inflation" (Cambridge University Press, 2008).
Shih: The most likely opponents of strict monetary policies are powerful "princeling" officials -- children of the Communist Party's founders
I don't see the connection between "princelings" and the technocrat/populist divide. There are princelings who are connected with economic interests in the coastal cities, but there are also princelings who are "technocrats" while at the same time there are a lot of local officials who want high growth and see food inflation as a good thing, that aren't princelings.
Shih: China's major banks, all of which are majority state-owned and run by managers appointed by the Communist Party, are simply ignoring decrees issued by the highest authorities.
This is partly because the "highest authorities" are issuing conflicting orders and in the presence of conflicting orders, people will do whatever they think is in their self-interest. The people who appoint the managers (CIC) are a different set of people than the people who are issuing the tightening orders (PBC) and have very different incentives.
Personally, I see this sort of policy disagreement as more of a good thing than a bad one. It is frustrating when you think that you have the "right policy" and you see all of this "bureaucratic infighting and interference" in the way of implementing what are self-evidentally correct policies. However, it's often not clear what the "right policy" is, and having people argue with each other a lot slows decision making, but it keeps you from making Great Leap Forward-level mistakes.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (2) for "Victor Shih on China’s credi...
- 2/21/2008 8:53 PM
December, 2007