Has China started deleveraging? Not yet and…expect even more financial and real leverage in 2019

Much has been discussed about China ’s deleverage process but the aggregate impact was muted. The choir for curbing leveraging was the loudest when the Financial Stability and Development Committee was set up under the auspices of the State Council in 2017 . Since then, a number of bold measures were taken to reduce risks in shadow banking, such as entrusted loans and peer-to-peer lending . However, the measures are not enough to reduce the overall indebtedness of the Chinese economy, neither in financial nor real terms. On financial leverage, there has been a clear deceleration as shown by the slowdown in total social financin g but still not enough to talk about deleveraging as its growth rate is still above nominal GDP. This is even more the case when incorporat in g new forms of shadow banking to the standard definition of total social financing, such as P2P lending, asset back ed securities , as shown in our “augmented” measure of total social financing. For the real economy, the debt-to-GDP continued to increase. The only sector which has seen deleveraging is corporate but not the public or the household sectors . Going forward, we expect both banks’ credit and bond financing to increase in 2019 following the measures announced by Chinese authorities. China will pursue a “stick and carrot” approach to force lending to private firms , which will increase corporate leverage, especially in the private sector. The fiscal stimulus will also increase government debt, and it is not plausible to expect households to save enough to outweigh such trends as they are encouraged to boost consumption to support growth. The key question is whether financial leverage will further climb and in what form. More specifically, it is a matter of whether the crackdown on shadow banking will come to an end. Banks have become the key actors to give new loans to help achieving the growth target. And we believe new forms of shadow banking may flourish to support banks in this endeavor. That said, traditional wealth management product s and P2P lending may continue to suffer, but new financing channels may be introduced as more banks have set up their own asset management companies (AMCs). In the same vein, w e expect more asset securitization by banks to free space in their balance sheets for new lending notwithstanding the tighter regulation regarding harmonization of asset management products. In fact, new venues for banks to offload their assets are mushrooming, including setting up wealth management subsidiaries . As for the real economy, more support will be given to the private sector through more and cheaper access to credit. More tax cuts and local government bond issuance will be used to support the economy at the cost of public debt expansion. Therefore, we expect China to choose growth over deleveraging in 2019.