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Rising credit impulse poses mixed outlook for China – Nomura

Nomura’s Asia desk reports that credit impulse trends signal a mixed cyclical outlook as well as medium-term caution, as the impulse is largely rising in countries where credit is misallocated.

In Asia, credit trends outside of China do not receive as much attention as they should. As most Asian economies are bank dependent, the credit channel plays an important role in policy transmission. Moreover, the credit intensity of growth tends to be higher in cyclical sectors such as manufacturing, trade and housing, so credit trends can offer insights into where an economy is headed. We offer three such insights.

#1 Gulf between household and business loan growth remains

Outstanding bank credit growth in Asia has trended lower since 2010 – in line with falling nominal GDP growth – in intermittent cycles. The last mini-cycle started in 2017, peaked in mid-2018 and appears to have stabilized in Q3 2019, but has yet to pick up decisively.

A split of bank credit across different sectors shows that, while credit growth has slowed across both household (mortgage and other consumer loans) and business loans (industrial and other services), the slowdown of the latter (typically used for productive purposes) has been sharper. Business demand for loans has likely been weaker due to the slump in exports and capex amid global uncertainties. Household credit growth has exceeded business credit growth by an average of nearly 3pp since 2015 (Figure 2).

Within household, mortgage lending growth has also moderated, partly reflecting tighter macroprudential norms but, at ~10% y-o-y in Q3 2019, it remains quite healthy (Figure 3).

In 2019, Asian central banks cut policy rates and eased liquidity in order to support higher growth, particularly in business credit (few countries have maintained housing restrictions), but the risk of history repeating itself (i.e., household loans continuing to grow at a faster pace and adding to the overall household debt burden) remains.

#2 Credit productivity has fallen in North Asia but remains higher in South/Southeast

Credit efficiency – or the growth bang for each dollar of credit – differs between North Asia and parts of South and Southeast Asia.

Figure 4 shows our estimate of the incremental credit output ratio. Similar in concept to the incremental capital output ratio, we calculate it by dividing the change in credit-to-GDP ratio by real GDP growth for each country. The ratio measures productivity of credit, with a higher ratio indicative of lower credit productivity, and vice versa.

We find that countries with elevated non-financial private debt (China, Hong Kong, Taiwan) tend to have lower credit productivity, while the ones with lower non-financial private debt (India, Indonesia, Philippines) have higher credit productivity. In China, this reflects overinvestment in the past. In advanced economies, this likely reflects less scope for high return on capital (due to less profitable investment projects).

#3 Credit impulse is rising in North Asia

Credit impulse is an important indicator of the cyclical growth outlook. Does the credit impulse signal green shoots? Is credit impulse supply (i.e. policy) or demand driven?

In Figure 5, we plot the credit impulse versus real GDP growth across Asia ex-Japan. A cursory glance suggests the relationship between credit impulse and growth cycles differs across countries. Credit impulse leads (in China), lags (in Philippines, Thailand) and is mostly coincident with growth elsewhere. However, ultimately, the two do tend to move in sync, with growth sometimes better measured through indicators other than real GDP growth, as is the case in China (see Gauging China’s credit impulse and its impact on the economy and financial prices, 15 November 2019). Our estimates suggest divergent trends:

  • Rising credit impulse: China, Taiwan, Hong Kong, Thailand
  • Neutral credit impulse: Singapore, South Korea
  • Falling credit impulse: India, Malaysia, Philippines, Indonesia

In our view, some of this divergence is consistent with the divergent monetary policy transmission via the bank lending channel (see Box 10 in Asia in 2020: Glass half full and half empty, 9 December 2019). For instance, policy rate cuts have resulted in nearly full pass through to bank lending rates in Thailand, but only a partial pass through in India, Indonesia and the Philippines. This, in turn, is a result of both demand and supply-side factors. In the Philippines, it reflects the lagged impact of tight liquidity (in 2018), although we expect a faster transmission to now occur as Bangko Sentral ng Pilipnas has cut the RRR by 400bp later in 2019. In India, elevated credit risk due to the shadow banking crisis (supply-side shock) and weak demand have tightened credit conditions. Falling credit impulse in Malaysia likely reflects weak domestic demand, in our view.

These divergent trends imply that the economic cycle in each country will depend on the domestic credit cycle and the exposure to the global export/tech cycle. For instance, Taiwan is positioned to benefit from both the tech upcycle and a rising domestic credit impulse. Korea is benefiting from the former (tech), but its domestic credit impulse is just stabilizing. India, on the other hand, does not benefit from either, which is why we expect growth to disappoint. Indeed, we expect the monetary policy cycle to differ across the region with further rate cuts likely in China, India, Indonesia, Malaysia and Thailand, while rates are likely to stay on hold elsewhere.

Two conclusions

First, from a cyclical standpoint, it is a mixed outlook. The upturn in China’s credit impulse will benefit some export-oriented economies, but mixed credit impulses elsewhere suggest aggregate GDP growth is likely to follow a U- rather than a V-shaped growth profile. Second, from a structural standpoint, our analysis points to a cautious outlook as credit impulses are rising in countries where credit is misallocated, which can aggravate medium-term challenges of high debt and declining productivity.

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