China Banks Rein in Lending but Economy’s Growth Prospects Remain Strong

As if the stock market hadn't received enough bad news yesterday (Tuesday), reports surfaced that China's banks have nearly hit their lending quotas for the year – meaning the world's fastest growing, and second-largest, economy will cool considerably over the next few months.

However, the news – out of China at least – might not be as bad as it seems.

Political strife resonated throughout the investing world yesterday as North Korea and South Korea exchanged fire over Yeonpyeong Island and Irish Prime Minister Brian Cowen pledged to dissolve that country's government and allow for an early election in January.

Strictly economic headlines weren't any consolation as it was revealed that China's banks are unlikely to extend many new loans as 2010 draws to a close.

China's banks extended about $1.03 trillion (6.88 trillion yuan) of new loans this year through October according to the Bank of China (BOC). That means banks have room to lend just $93 billion (620 billion yuan) in November and December before Beijing's quota is exhausted. And the mainland's 21st Century Business Herald reported that lenders have made close to $90 billion (600 billion yuan) of new loans so far this month.

Now, banks are only extending loans after existing ones are repaid. Lenders also are cutting holdings of discounted bills – short-term loans used by smaller companies to stay liquid – to make room for longer-term debt, Bloomberg News reported.

Beijing removed the annual lending quota in November 2008, and then sat back as new loans soared to a record high $1.4 trillion (9.3 trillion yuan) last year. In fact, China's banks lent out about $1.08 trillion (7.37 trillion yuan) – nearly double the total loans extended throughout all of 2008 – in just the first six months of 2009.

Beijing replaced the cap in January to curb inflation and tame its blistering property market. And Ting Lu, an economist for Bank of America Corp.'s (NYSE: BAC) Merrill Lynch unit, says regulators will work diligently to enforce the government's lending target of $1.129 trillion (7.5 trillion yuan).

"We don't expect regulators to play chicken; we expect some harsh administrative measures, and we expect the market to overreact to those harsh measures," said Lu.

The Shanghai Composite Index has tumbled 11% since hitting a seven-month high on Nov. 8. However, lending conditions are only expected to tighten from here on out. The government may limit new lending to $1 trillion (6.6 trillion yuan) for 2011 – a 12% decrease from this year's target.

The BOC last month raised interest rates for the first time since 2007 and on Friday told banks to set aside more deposits as reserves for the second time this month. The central bank raised the reserve requirements by 0.5% – the fifth such hike this year.

The move – which will drain about $52.7 billion (350 billion yuan) from the financial system, according to data by Bank of America Merrill Lynch – came after China's consumer price index rose 4.4% in October, its fastest pace in two years.

Indeed, too much growth – rather than a lack thereof – is China's main concern.

China's economy expanded by 9.6% in the third quarter and could slow down to 8.7% in the fourth quarter, according to the State Information Center (SIC) of China.

"It's important to remember that China's problem is that it's growing too fast," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "Ireland would give its right arm to be in this situation. And the U.S. Federal Reserve is throwing everything it has at the economy to ensure just 2% growth."

Tighter lending will reduce the economy's dramatic pace but there's still nothing to suggest that China will suffer more than a slight decline in growth, says Fitz-Gerald. Long-term, China is well positioned for sustained growth.

"This is a nation that's tapping the brakes on. This is not a stop to lending. This isn't going to put the country out of business. It's the responsible thing to do," said Fitz-Gerald. "They've studied the mistakes of Japan and the U.S. and are doing what we should have done in the 1990s."

News and Related Story Links:

• Money Morning:
  What China's Investment Trends Are Telling Us Now
• Money Morning:
  China Outrunning the Global Recovery and Still Looking Ahead
• Money Morning:
  China is Doing Exactly What the United States Should be Doing – Looking Ahead
• Bloomberg:
  China's Banks Said to Near Loan Quotas, Halt Growth