The latest data on social financing in China shows that the Middle Kingdom bond market posted negative growth over a recent quarter-long period.
During the period from December 2016 to February 2012 non-financial enterprise debt financing posted continuous negative growth, falling by nearly 1.4 trillion yuan compared to the same period last year.
Non-standard financing picked up the slack left by China’s contracting bond market, with entrusted loans, trust loans and discounted notes collectively surging growing by nearly 2 trillion yuan, an increase of 1.2 trillion yuan compared to the same period last year.
The latest changes in China’s social financing – a broad measure of credit and liquidity in the economy, runs contrary to the general development trend over the past several years.
Since 2012 Beijing has placed heavy emphasis upon suppressing risk associated with China’s shadow banking sector and non-standard forms of leading, which has led to a poor performance for entrusted loans, trust loans and discounted notes.
The heavy-handed regulation of these alternative forms of lending gave greater impetus to China’s standardised bond market, whose scale has steadily grown since 2012.
The reason for the latest turnaround is likely deleveraging policies directed at the bond market that were launched last year.
Bond prices surged in 2016 as large volumes of funds fleeing from irregular fluctuations in stocks poured into the market, which caused the leverage levels of certain financial institutions to rise markedly.
This prompted China’s regulators to introduce bond-related leverage-reduction policies in the second half of 2016, which reduced risk but also put a squeeze on the bond market.
In response to these measures some actors in the real economy turned back to the shadow financing sector to service their financing needs.
The negative impact of a shrinking bond market on China’s real economy is already apparent, with paid-in capital for fixed asset investment posting 8% negative growth during the past two months compared to the same period the year previously, and hit its lowest growth rate in over a decade.
An increase in shadow banking could also exacerbate structural imbalances in Chinese financing, with paid-in capital for real estate investment surging 7% during the same period, while the figure for non-real estate investment declined 16%.
Analysts contend that because it’s more difficult for regulators to monitor shadow banking, a larger volume of funds could be channeled towards the real estate sector where returns are higher.
Another negative impact could be an increase in the cost of financing for actors in the real economy, given that China’s banks are still constrained in their lending proclivities by state-ownership, while bond availability abets their ability to lend to companies.
While the big banks possess greater ability to attract deposits, they remain cautious when it comes to dispensing loan and their deposit funds are often in excess. The big banks are more willing to invest in the real economy when they can instead purchase bonds directly.
When bond markets are constrained, however, the big banks will tend to lend their excess funds to small and medium-sized banks via interbank deposits in order to support their loan growth to actors in the real economy.
This increases the number of intermediary chains in the capital flow process, thus raising financing costs for Chinese companies.