China:December credit data surprised to the upside

Stronger than expected credit growth occurred against a backdrop of (1) lower realinterest rates amid higher inflation (although interbank interest rates increased, themagnitude of the rise was much smaller than the rise in upstream inflation); (2)stronger corporate profitability, which increased the incentive for firms to expandtheir business activities: industrial companies’ profit growth accelerated from around5%yoy at the start of the year to almost 15%yoy in November; (3) strongerexpectations of monetary tightening could have led some companies to borrowmore than otherwise for fear of not being able to access loans later; and (4) the impact from property policy tightening has yet to feed through to mortgage loans asthere is typically a lag between property sales and the amount of mortgage loansextended.

But the amount of local government bond issuance fell significantly, partially due tovolatility in the fixed income market. Broad money growth was not as strongbecause of the drag from fiscal policy. (Fiscal deposits fell by around Rmb 1156 bn inDecember, a smaller decline than in the same period in previous years.) Fiscalexpenditure was very front-loaded last year, which meant that December netexpenditure was likely to be much smaller than usual. FX outflows likely remainedlarge in December, which also dampened M2 growth.

Taking into account all these factors, broad liquidity supply growth to the realeconomy was not quite as strong as the credit data alone would suggest. Adeceleration in credit should be welcome news, especially as growth has held up sofar. Indeed, growth may be above potential given that inflationary pressures are stillsignificant. This is especially obvious in terms of upstream PPI, but non-food CPIinflation has risen somewhat as well. If credit demand remains as strong in January,which is fairly likely, then the central bank may need to take more decisive action tocontrol the quantity of credit supplied. Without a further rise in interbank interestrates, the effectiveness of credit quantity control is constrained, especially in themore broadly defined credit. In the past, commercial banks have tended to create anumber of new financial products to avoid such controls, and this behaviour willlikely continue. We see modest upside risks to our interbank rate forecasts.