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china rebalancing stimulus A miner works at a coal mine in Changzhi, Shanxi province February 26, 2009. China's energy use in generating each dollar of gross domestic product fell 4.5 percent in 2008, Liu Qi, deputy administrator of the National Energy Administration said on Thursday. REUTERS/Stringer
Reuters
Some sectors are easier to stimulate than others.

It’s getting harder and harder to stimulate China’s economy

By Gwynn Guilford

Awful August data shows that Chinese growth is sputtering once again. This might seem strange given that in May, the Chinese government loosened lending and launched infrastructure investment projects—moves touted as a “mini-stimulus.”

At least for smaller, non-state companies, it clearly didn’t work, based on the findings of China Beige Book (CBB), a research firm.

“[T]he true problem, still missed in most policy discussions, is that intense stimulus wouldn’t work,” says the report. “Liquidity is excessive yet credit participation has cratered over the past two years. Supply is there, but demand is not.”

Who isn’t borrowing?

The report’s findings suggest that it’s not a lack of cheap credit that smaller Chinese companies are struggling with. So far in the third quarter, half as many firms have borrowed as in the first quarter of 2012, when CBB’s polling began. The survey, which examines more than 2,100 firms around China, shows that fewer than 20% of the firms borrowed at all in the third quarter (from banks, the bond market, shadow finance firms, or otherwise), down from 29% in the third quarter of 2013. Capital expenditures, meanwhile, have sagged to the lowest level since the survey began.

Why the holdback? It might have something to do with credit becoming more expensive; the mean bank loan interest rate rose to 7.47%, up from 6.95% last quarter. But the trend has been consistent enough since the second quarter to suggest something more systemic is at play: that just as private firms are furiously trying to pay down debt, domestic consumption is now flagging. CBB reports that the retail sector, which it considers a proxy for consumer behavior, saw only sluggish growth—as did wages.

So who is borrowing, then?

The strange thing is, nearly half the bankers CBB spoke with reported a rise in total lending to businesses, up from 35% in Q2. But they’re not lending to new customers—only 1% said that 30% or more of their business was with new borrowers.

The likely recipients are state-owned companies, local government financing vehicles, and firms in strategic state sectors. Though it might be coincidental, coal and iron ore—two notoriously inefficient sectors—saw a big rebound in third-quarter output growth, despite the government limiting loans (paywall) to those sectors earlier this year. “The government appears to have halted its crackdown on overcapacity in those sectors—and they responded by stepping back on the gas pedal,” says Leland Miller, president of CBB.

There’s one more sector of the Chinese economy that picked up in the latest quarter: shadow lending, via off-bank-balance-sheet finance channels. The proportion of loans coming from shadow finance rose seven percentage points, to 31%, while just 12% of firms received bank loans.

Tricky stimulus conditions ahead

The Chinese government needs to prevent a drop in growth so sharp it violently disrupts the economy. And eventually, that probably means more stimulus. What CBB’s research suggests, though, is that monetary stimulus won’t be enough. With companies so reluctant to borrow, if the government wants to get investment going, it’s going to have to do it itself.