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PineBridge: The Evolving China Mosaic

Monday, June 05, 2017

PineBridge: The Evolving China Mosaic

The unusual and colorful nature of American politics has diverted attention from what is a more central issue to the global economy: China.

global economy: China.

China has begun a gradual rationing of credit, away from real estate and old line manufacturing into infrastructure projects. Will this more productive use of a less gushing credit spring keep the Chinese economy — and, by extension, the rest of the world — from slowing?


For anyone interested in the direction of interest rates, securities markets, and the global economy, the answers to that question couldn’t be more important or more difficult to predict. Given the dubious value of China’s official statistics, some throw their hands up at the challenge of cracking the black box. We view the challenge of assessing the prospects for the world’s lynchpin economy as a job of assembling a mosaic.


China has recently engaged in “qualitative rationing.” Total credit will still grow, in our view, but more slowly and will be aimed more surgically into what the government believes are more productive uses while still keeping the economy moving forward. Party leaders were chastened by the experience of 2015, when a “quantitative rationing” and abrupt slowdown of Total Social Financing (a broad based measure of credit) caused a China and global slowdown. This time, they are being more cautious.


They are taking a new, harder look at wealth management funds created by banks as off-balance sheet vehicles, which appear to be lending for speculative purposes. Given China’s increasingly levered status, they prefer to see incremental credit directed to the ambitious rail, road, port, and pipeline projects known as the One Belt, One Road plan to connect China more efficiently with Central Asia and Europe. The government has said it plans to invest about $1 trillion in this massive effort, which is aimed at cementing China’s economic dominance. At issue is whether the shift implies a lull, with real estate and commodity-based activity slowing before infrastructure spending rises. In all likelihood, we think this will happen. Yet in contrast with 2015, when China was the only party investing and their slower credit expansion slowed the world, today more businesses around the world are investing, which would likely cushion a Chinese pullback.


Why China’s change? The government is responding not only to elevated leverage, but also to some of the same encouraging signs that we see. The consumer has grown rapidly as a share of their economy and now is in better shape to carry their economy along in a less credit-intensive manner. Nevertheless, cooling China’s over-heated real estate markets still contains risks. Withholding credit could send prices of houses down sharply, an asset that underpins their banks. So supply of new construction is being managed down in tandem. Older, shoddily-constructed housing is also being vacated to make room for recent new construction.


The picture emerging from the mosaic, therefore, is somewhat optimistic. But pointillism is not photography, so where China is concerned, caution — and continued data-gathering — is essential.


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