China shadow banking chills stimulus hopes

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Two months ago calls for broad-based stimulus in China were all the rage, but a sudden spike in shadow banking has led analysts to revise their expectations for looser monetary policy.

Aggregate social financing, a measure of credit that covers bank lending and shadow banking activity, hit one-year high of 1.69 trillion yuan ($273 billion) in December, up from 1.15 trillion yuan the previous month, official data showed on Thursday.

"A surge in shadow bank credit – entrusted loans, trust loans, banker's acceptances, corporate bonds and non-financial enterprises' domestic equity – was responsible for December's considerably larger than expected increase in aggregate financing," said Tim Condon, head of Asia research at ING in a note on Friday, noting that shadow bank credit exceeded new yuan-denominated loans for the first time in 2014.

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Shifting rate expectations

China's central bank surprised markets by cutting interest rates for the first time in two years in November, sparking expectations for further policy easing via interest rate or reserve ratio requirements (RRR) cuts. Tight funding conditions also fuelled hopes for RRR cuts late last year. The seven-day repo rate, a closely-watched measure of interbank lending costs, spiked suddenly to an over one-year high in mid-December, prompting speculation for central bank action to boost liquidity.

But Thursday's data reduce the likelihood that the People's Bank of China (PBoC) will cut the RRR for lenders, Condon said: "We are reviewing our forecast of 100 basis-points of RRR cuts in the first half of the year for downward revision."

Gavin Parry, managing director of Parry International Trading, agrees. Thursday's data "only proves further to us that the PBoC is less reluctant to reach for Thor's Hammer of broad monetary policy," he said in a note, referring to the fearsome weapon in Norse mythology.

Shadow banking rising

Shadow banking was fairly stable last year after Beijing introduced regulatory measures to clampdown on the sector, such as stricter financing rules for trust companies. During the July-September period, the shadow banking sector of China's total social financing contracted for the first time on quarter since the global financial crisis.

However, those tightening measures may be the very reason for December's surge, according to Barclays.

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"We suspect that borrowers including local government financing vehicles (LGFVs) could have accelerated their financing activities through shadow banking channels, since they might experience difficulties in accessing bond market for new issuance as a result of tightening regulations/declining support from provincial government on new debt," analysts said in a note on Friday.

A policy dilemma

The sudden spike in shadow banking credit leaves the central bank in a catch-22 situation, Parry said.

"Here is the issue for the PBoC; it is facing rampant speculation bubbling in the economy like the stock market, while also facing weaker loan demand, local government funding needs and deflationary forces," he said.

Other data on Thursday showed new loan growth of 697 billion yuan in December, well below estimates for 880 billion yuan. Meanwhile, consumer inflation remains near five-year lows, December data showed last week. Both factors add pressure on the central bank to ease monetary conditions amid a backdrop of overall slowing economic growth.

"These concerns only make it more evident that the PBoC will hold its macro neutral posture with easing tendencies towards micro management," Parry said, as opposed to rate and RRR cuts.