As the Chinese government's 4 trillion CNY (USD $580 billion) stimulus program began, new loans extended by banks in China surged to 4.58 trillion CNY (USD $670 billion) during the first quarter of this year, or to 244.36 per cent, from the same period last year. However, a recent audit report from China National Audit Office (CNAO) for the stimulus program revealed that bill irregularities were found in some enterprises, which exaggerated the scale of banking deposits and lending.
Falsified contract discounted; while bank funding not put into real economy.
According to the Wall Street Journal, CNAO reported on May 18th that some enterprises falsified contracts and invoices for note discount due to a lack of oversight by local banks. This enabled some of the funds to be reinvested into bank deposits to profit from interest-rate differentials instead of going through real economy. The report didn’t reveal the amount of irregular funds, but stated that it caused a false increase in the deposit and lending scale, and an increase in bank systematic risk.
Feng Wei, an analyst with Beijing Guohai Securities, said to Asian Times, "Medium- and long-term loans accounted for 41 per cent of new lending in the first quarter, while bill financing accounted for about 33 per cent." He further noted, "The high proportion of bill financing was a cause for concern, as part of the new loans involved were turned into bank deposits, stock market funds or property funds, instead of supporting the real economy." According to many investors, the sharp rise in the Shanghai Composite Index could be, to some extent, ascribed to lending funds flowing into the stock market.
The increase in China's economy in the first quarter also confirmed that lending funds was not completely put into real economy. A researcher of the Chinese Academy of Social Sciences said that if all the 4.58 trillion CNY of first-quarter new loans had been spent, China’s economy should have been close to overheating already, but in fact, China's economy had only risen by 6.1 per cent, lower than 6.4 per cent for last quarter.
New loan policy made China's domestic demand even lower
"Policy makers adopted a response to this that in retrospect undermined the growth of consumption", wrote Michael Pettis, senior associate at the Carnegie Endowment for International Peace, in an article for the Wall Street Journal.
Since the 1990s, Chinese banks have accumulated many nonperforming loans. Pettis wrote, "Beginning in the late 1990s and continuing for much of the past decade, bank regulators repaired bank balance sheets in part by using government resources to recapitalize the banks and in part by setting deposit rates much lower than lending rates. The spread between the two was kept wider than the market would otherwise have dictated to ensure high profits for the banks."
Accordingly, Pettis pointed out that consumption was affected in two ways, "By raising and transferring huge amounts of taxpayer resources to pay for expected losses, of course, the regulators captured a significant portion of Chinese income that could have gone to consumption. More significant may have been policies aimed at keeping corporate borrowing rates low to slow the growth rate of nonperforming loans, and deposit rates even lower to ensure bank profitability. In effect Chinese savers were forced into accepting brutally low returns on their savings to help recapitalize the banks via profits reaped on these wide spreads."
Under the current stimulus policy, he said, "like those aimed at engineering massive loans to capital-intensive manufacturing at very low interest rates", some policies "forced rapid growth in domestic production. This aggravated the overcapacity problem that only domestic consumption can fix." However, the current loan policy constrains consumption growth.
Finally Pettis concluded, "...anything that limits future growth in Chinese consumption will necessarily limit Chinese economic growth. The explosion in new lending may do just that. In exchange for a temporary bounce, by encouraging a potential new round of massive capital misallocation China may have locked itself into many years of sub-par economic growth."
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