China Confronts the Pain of Deleveraging, and Blinks

(Bloomberg Opinion) -- China’s falling stock market has prompted a flurry of activity to prop up prices. From delaying forced sales of pledged stock to turning on the credit engine again, authorities see the declines as emblematic of concerns over the economy.

Investors have pulled about 3.2 trillion yuan ($460 billion) out of the market this year, according to net capital data from Wind, a financial information company. The exodus is even more striking given that foreign investors piled in after MSCI Inc. added A shares to its benchmark indexes. Absent those inflows, the slump would have been even worse.

What’s notable is the consistency of the outflows. In the first 207 trading days of 2018, there were only 52 with net capital inflows. Money is exiting the market more frequently and in larger amounts. Net inflows have averaged 15.4 billion yuan, while net outflows have averaged 26.5 billion yuan on the 155 days when the balance was negative.

When Xi Jinping was confirmed for a second term as general secretary of the Communist Party in October 2017, new total social financing was growing at 32 percent, with outstanding stock of this broad measure of credit climbing at 14 percent. Since then, Beijing has tightened credit significantly. New total social financing contracted 20 percent in the seven months through July.

This has resulted in an enormous shift in the availability of finance to the economy. If the measure of new credit had remained flat or grown at a modest 10 percent, this would have meant additional financing of 2.3 trillion yuan to 4.1 trillion yuan. That expected financing gap roughly matches the 3.2 trillion yuan drawdown from the stock market.

The deleveraging campaign has been hitting asset prices throughout China. Prices of almost all metals, driven by Chinese consumption, are lower than a year ago. Real estate transactions are down and prices increasingly are under pressure. Both markets are inextricably linked to credit flows, with commodity prices driven by financial inflows into trading vehicles such as wealth management products, and housing buoyed by an explosion in consumer debt.

Beijing’s tightening has put pressure on companies and individuals to pay back debts and get liquid. Regulators have rushed to assure private firms they will get the funding they need from a financial system that traditionally favors state-owned businesses. They have also rolled out bailout packages to help companies that pledged shares in exchange for loans. The balance of margin and security loans has dropped by 25 percent, or 261 billion yuan.

Beijing made the right decision to tighten the credit fire hose. Yet even with the slowdown, total social financing continues to grow about about 1 percent faster than nominal GDP. In other words, asset prices have yet to feel the knock-on impact of a genuine deleveraging. If asset prices are diving even as debt continues to climb, how much worse would the declines get in the event of a contraction?

As Beijing announces its intent to turn on the liquidity spigots again, this raises the question of whether China is willing to take the pain of restricting credit. The suspicion will be that the government will simply try to buy its way out of an uncomfortable situation again.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Christopher Balding is a former associate professor of business and economics at the HSBC Business School in Shenzhen and author of "Sovereign Wealth Funds: The New Intersection of Money and Power."

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