Regulatory merger keeps China on course for deleveraging

The combination of banking and insurance regulators offers an opportunity to co-ordinate debt reduction measures

A key measure of leverage in China has dropped to its lowest level in almost five years, offering hope that the country’s efforts to improve regulatory co-ordination and channels for financial intermediation are bearing fruit. But authorities can’t rest on their laurels yet, and clearly need to stay the course to avert any systemic shocks.

The credit-to-GDP gap – the difference between the private non-financial sector credit-to-GDP ratio and its long-term trend – slipped to 16.7% in the third quarter of 2017. That was its lowest level since the final quarter of 2012, and down from a peak of 28.9% in March 2016, shows data compiled by the Bank for International Settlements.

Although this marks the sixth straight quarter of declines in the measure, international bodies such as the BIS and International Monetary Fund reckon more needs to be done to curb financial exuberance. The challenge is to implement deleveraging measures without further dampening economic growth, and this is where regulatory synchronisation can come in handy. Authorities have set a growth goal of around 6.5%, down from the 6.9% achieved in 2017. Any slip-ups will threaten the stated goal of doubling GDP in the decade to 2020, and may push the nation into a debt-deflation trap.

Data now shows the second-largest economy has made progress with its three-year campaign to curb financial risk, with results visible at the sector levels: growth in bank loans, shadow banking and wealth management products has cooled, while excess industrial capacity has been reduced.

However, the corporate debt level is still well above the average of both the developed and emerging markets. The debt-to-GDP ratio exceeds 250%. Although lower than most high-income countries, that is higher than the ratio for most emerging market economies. And what is concerning is the fact it has nearly doubled in the past 10 years.

The credit gap, though declining, still remains above the early warning indicator threshold of past financial crises. The BIS, which groups China among economies most at risk of a banking crisis, puts at 9% the optimal early warning indicator threshold that minimises the noise-to-signal ratio while capturing at least two-thirds of historical crises. China’s reading is also the second highest, only behind Hong Kong, among 29 nations surveyed by the BIS.

Banking and insurance combined

Recent moves on the regulatory front and deleveraging have been encouraging, however. On March 13, China announced it was merging its banking and insurance regulators to tighten oversight of the $42 trillion sectors and to give authorities more clout to crack down on riskier lending practices. The same day, it also gave policymaking bodies, such as the central bank, more rulemaking powers in the biggest regulatory shake-up in years.

Those moves followed a barrage of new rules unleashed by regulators earlier this year to monitor bond trading deals and curb shadow banking. Those rules, in turn, came just over a month after the inaugural meeting of a new Financial Stability and Development Committee. This committee, which has its offices in the People’s Bank of China, sits above the current assortment of regulators, and is seen as a policy harmonisation body.

During the first session of the 13th National People’s Congress in March, authorities signalled that reducing the debt and leverage of state-owned enterprises will remain a focus for the central government, and such companies will be forced to raise equity and sell non-core assets.

On March 13, China gave policymaking bodies, such as the central bank, more rulemaking powers in the biggest regulatory shake-up in years

Government spending is being checked, as well, with plans to cut the nation’s budget deficit target for the first time since 2012. The dual goals of deleveraging and maintaining a reasonable economic expansion may not conflict in theory, but point to a tricky road ahead.

The past is littered with examples of watchdogs acting unilaterally to curb excesses in their respective spheres of influence or authorities moving too fast, only to backtrack. That has led to market disruptions, such as the bond market turmoil last year and the central bank’s funds injection to ease systemic strains in the interbank market in June after three quarters of tightening.

Such doses of monetary stimulus are unsustainable and unnecessary in the long run. Which is why a co-ordinated regulatory response aimed at curbing financial risk is required to meet president Xi Jinping’s promise to deliver a moderately prosperous society by 2020.

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