China has recorded its first contraction in bank loans since July 2005, marking a significant shift in its financial landscape. This decline in new corporate borrowing, coupled with increased debt repayments by households, has raised concerns about the country’s economic trajectory. The contraction deepens China’s ongoing struggle with weak credit demand, as both families and businesses remain cautious amid a protracted property slump.
Concerns of a Balance Sheet Recession
The recent contraction in bank loans has fueled fears that China might be heading toward a “balance sheet recession,” a term used to describe Japan’s economic malaise in the 1990s. This economic condition, as articulated by Richard Koo, chief economist at Nomura Research, involves a period where declining asset prices lead families and businesses to focus on repaying debt rather than spending, ultimately stifling economic growth.
Lynn Song, chief economist for Greater China at ING Bank, acknowledges the risk of a balance sheet recession but notes key differences between China’s situation and Japan’s past challenges. He stresses the importance of stabilizing asset prices to prevent entrenched pessimism from further impacting the economy.
Economic Indicators and Domestic Demand
Additional economic indicators point to a weakening of domestic demand, placing pressure on President Xi Jinping’s annual growth target of approximately 5%. Core inflation, excluding volatile food and energy prices, rose by just 0.4% in July—the lowest increase since January. This follows a prolonged decline in economy-wide prices over five consecutive quarters, the longest downturn since 1999.
Retail sales data, expected on Thursday, is anticipated to show sluggish performance despite a slight seasonal uptick. Moreover, a key gauge of services activity, including retail, was nearing contraction in July for the first time since the previous year.
Market Reactions and Bond Yields
China’s bond markets are reflecting growing concerns about economic stagnation, with yields on government and corporate bonds falling to record lows. Investors have increasingly turned to fixed-income securities over stocks, despite recent interventions by Chinese authorities aimed at curbing the negative impact of falling yields.
The People’s Bank of China has made several verbal warnings and regulatory adjustments in response to the bond market’s volatility. Policymakers are wary of a feedback loop where falling yields further depress economic expectations.
Comparisons with Japan’s Economic Crisis
Ren Zeping, a noted analyst and former chief economist at China Evergrande, draws parallels between China’s current situation and Japan’s balance-sheet recession of the 1990s. He points to similarities such as high household savings, weak loan demand, low consumer and asset prices, and elevated real borrowing costs.
However, experts highlight significant differences that may prevent China from experiencing a Japan-style economic stagnation. For instance, China’s household debt-to-GDP ratio has remained relatively stable since the pandemic, and the corporate sector, including state-owned enterprises, continues to see rising debt levels. Additionally, the collapse in real estate prices in China has been less severe compared to Japan’s experience.
Global Economic Context
The Plaza Accord of 1985, which led to the appreciation of the yen and diminished Japan’s export competitiveness, was a critical factor in Japan’s economic troubles. In contrast, China’s more flexible foreign exchange policy offers some insulation against similar shocks. Larry Hu, head of China economics at Macquarie Group Ltd, notes that a true balance sheet recession would involve significant deleveraging by companies, which is not currently evident in China.
Conclusion
China’s recent bank loan contraction has intensified concerns about a potential balance sheet recession, echoing Japan’s economic troubles from decades past. While similarities exist, notable differences suggest that China’s path may diverge from Japan’s historical experience. Monitoring these economic indicators and policy responses will be crucial in assessing China’s future economic stability.
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