Chinese credit crunch

The Chinese money market has been relatively calm in the past month without any major new credit events. Money market rates remains substantially below the elevated levels experienced in connection with the money market stress in June and December last year, albeit money market rates have edged moderately higher in the recent month. The spread between swap rates and government bond yields has also continued to decline and CDS-premiums for Chinese banks are largely unchanged in the past month at levels that can hardly be considered stressed.

The development in the money market also suggest that the Peoples Bank of China (PBoC) is so far not planning to ease monetary policy substantially. Liquidity conditions appears to have eased somewhat in the interbank market, but in 2014 the PBoC has so far not allowed excess liquidity in the interbank market to increase markedly. While some of the de facto monetary tightening in H2 13 has now been removed, money market rates in general remain higher than in H1 13.

Lower quality corporate debt remains very stressed albeit yield spreads for lower quality corporate debt have stabilised in recent months. The extremely elevated yield spreads for lower reflects that lower quality corporate debt faces very difficult refinancing conditions and corporate debt in general has been re-priced to discount higher default probability.

Total credit growth (measured by aggregate social finance) in March eased to 16.6% y/y from 17.6% y/y in February, driven mainly slower growth in credit from shadow finance sources. Growth in shadow finance in March declined to 24.9% y/y from 28.3% y/y in the previous month (down from 48% y/y May 2013). Both loans from trust funds and corporate bond issuance have slowed markedly albeit corporate bond issuance showed tentative signs of picking up in March. Entrusted loans (direct lending between non-financial corporations) are now the most important source for growth in shadow finance and could be the next target for a regulatory crackdown.

M2 money supply growth in March also eased to 12.1% y/y from 13.3% y/y in February. Both credit and money supply growth so far does not suggest a severe credit crunch in China, but on the other hand does not yet signal a solid recovery in H2 either.

Credit event risk will, in our view, again increase in coming months not least in late June, when liquidity demand usually increases markedly not least due to window dressing by banks and the expiry of wealth management products ahead of the end of half-year reporting to financial regulators. Hence, there is a substantial risk that we could see a replay of the money market stress that hit China’s market in June and December 2013.