Chinese credit crunch

It now looks like China will be able to get past June without a repeat of last year’s money market stress and hence a major hurdle for a recovery in H2 appears to have been cleared. Liquidity is usually tight in June due to tax-payments, windowdressing by banks and the expiry of many wealth management and trust products. For that reason the credit event risk is particularly high in June.

Our credit risk indicators have continued to decline across the board in the past month and are mostly back at levels from before the money market stress started in June last year. Overnight money market rates remain low and recently risk premiums for money market rates with longer maturities have also declined. The swap-government bond spread has also continued to decline fast and has now largely normalised. In the offshore market CDS premiums for China’s Sovereign debt and the major Chinese banks have also declined markedly in the past month.

While corporate bond yield spreads have declined for higher quality corporate debt recently, yield spreads for lower quality corporate bonds remain extremely elevated, underscoring that the market has adjusted to pricing a fundamentally higher probability of default for corporate debt.

There were tentative signs of stabilisation in credit growth in May. Growth in total social finance (TSF) that includes both traditional bank loans and other sources of credit (shadow finance) improved slightly to 15.2% y/y in May from 15.1% in April. Seasonally adjusted growth in TSF in May accelerated to 1.2% m/m from 1.0% m/m in April. This is the highest monthly growth in TSF since January. M2 money supply growth also increased slightly for the second month in a row to 13.4% y/y from 13.2% y/y in April but the message from money supply growth continues to be stabilisation rather than a pronounced recovery.

For shadow finance as a whole there are also tentative signs of stabilisation driven primarily by a surge in corporate bond issuance in April and May. The strong corporate bond issuance might to some degree reflect off-balance funding of the government’s mini-fiscal stimulus. However, new loans from trust funds remain weak and have virtually dried out in recent months. The overall picture remains that growth in shadow finance has slowed markedly and in the past three months growth has been close to growth in traditional bank loans.

Despite overall easier financial conditions credit event risk remains high. Companies dependent on funding from shadow finance sources like trust funds face very difficult refinance conditions particularly because a substantial amount of trust wealth management products will expire in the coming quarters. In addition, the current weakness in the property market is a concern.