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New buzzword for an economic game plan
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Chinese Premier Li Keqiang’s approach to economic transition has been dubbed “Likonomics” by British investment bank Barclays.
The buzzword has been quickly adopted by analysts and commentators, who use it to distinguish the new government’s economic tone from the policies of its predecessor.
Led by Premier Li, the State Council, China’s cabinet, has adopted a series of measures to guide the world’s second-biggest economy to a more sustainable growth path.
Analysts at Barclays sum up the approach as the three pillars of Likonomics: no stimulus, structural reform and deleveraging.
No Stimulus
Before the leadership handover in March, former Premier Wen Jiabao defended the government’s 4 trillion yuan (US$654 billion) stimulus package, adopted in 2008, as the right decision to protect China from the global financial crisis.
Analysts are still fretting over the decision.
They note that the Chinese banking system is still suffering from the aftermath of a credit explosion that resulted in mounting local government debt, property asset bubbles and potentially sour loans.
In recent speeches, Li reiterated that sustainable growth cannot be built on short-term stimulus.
The People’s Bank of China was reluctant to bail out banks in the recent liquidity crunch, probably the worst in a decade.
That added credence to the belief that the government is determined to deflate reckless credit expansion.
Li also has said the Chinese banks are not short of money and should make better use of their capital.
“We believe that the PBOC allowed the squeeze to teach banks a lesson on the risks of aggressive balance sheet expansion and large off-balance-sheet activities,” Dariusz Kowalczyk, senior economist at Credit Agricole Corporate and Investment Bank, said in a note commenting on the central bank’s unusual reaction.
“The goal is to stem the recent explosion of credit and avert a potential crisis in the future,” he added.
The government appeared willing to inflict pain on banks but did act to ease the liquidity squeeze before it threatened systemic stability or the survival of a major bank, he said.
Commercial banks on the mainland are at the center of Li’s bold and decisive reforms.
Chris Leung, senior economist at DBS China, said the government is taking necessary steps to mitigate risks in the banking sector.
Supply of money, although sufficient, is not driving real economic activities because the money is just changing hands, according to Leung.
Structural Reform
Interest rate liberalization seems at the top of the government agenda. Li said in March that new measures to deregulate rates would be forthcoming.
Last month the PBOC eased controls on bank lending rates as part of the overhaul.
The central bank said the move was aimed at helping lower financial costs for enterprises, improving independent pricing flexibility for banks and supporting China’s structural adjustment.
The cap on the maximum rate discount — 30 percent of benchmark rates — has been removed for commercial banks, allowing them more freedom to adopt differentiated pricing on loans.
“The removal of lending-rate controls is a major step forward in interest rate liberalization, but it has a more symbolic meaning and the impact on bank behavior will be very limited,” said Zhu Haibin, JP Morgan China chief economist.
“No bank in practice offers discounts close to 30 percent from the benchmark lending rate,” he said. “Only 11.4 percent of bank loans extended so far have a 10 percent discount rate.”
In fact, United Overseas Bank said 64 percent of loans in the first quarter were priced above the benchmark rate and that scenario is likely to persist in the near future.
Analysts also point out that the cap on deposit rates probably won’t be removed until a deposit insurance system is in place. Moreover, an exit mechanism to handle insolvent financial institutions is also needed to deal with any meltdown that may result from rate deregulation.
Unlike previous reforms, where smaller lenders took a bigger hit, the recent changes to the lending rate floor will have their largest impact on the Big Four banks, which all have relatively large exposures to large state-owned enterprises capable of negotiating lower lending rates, said Moody’s Investors Service.
The Big Four are Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China and Bank of China.
Deleveraging
Unlike former Premier Wen, who criticized big banks for raking in excess profits at the expense of depositors, Li seems more concerned about the divergence in growth rates of credit assets and GDP.
Following the 4 trillion yuan stimulus package, China’s total credit increased from US$9 trillion in 2008 to US$23 trillion by early 2013. As for the proportion of credit against GDP, the growth has been from 75 percent to 200 percent, according to Barclays.
The bank said the PBOC’s recent move to curtail the credit bubble in the interbank market underscores the Chinese central government’s desire to deleverage and reduce future financial risks.
Li called for the banks to step up efforts to mitigate risks and to make better use of existing credit, suggesting they shift their focus to helping finance growth in the real economy, where output is created.
British scholar Richard Werner of Southampton University pointed out that lending for real estate should be curtailed because GDP measures only output and excludes existing assets, according to The Economist.
Barclays said deleveraging is likely to continue and some smaller, weaker banks could fail in the coming year.
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