Determination among consumers and businesses to pay down debt following a real estate market collapse is seen as a hallmark of Japan’s stumble into decades of deflation in the 1990s. – Bloomberg
BEIJING: China’s first bank loan contraction in nearly two decades has fanned fears the world’s No. 2 economy is careening toward a "balance sheet recession” as Japan did decades ago.
A plunge in new corporate borrowing combined with households preferring to repay debt saw bank loans shrink last month for the first time since July 2005. That deepened China’s years-long battle with weak credit demand, as families and companies battered by a property slump turned cautious in buying homes or expanding investment.
Determination among consumers and businesses to pay down debt following a real estate market collapse is seen as a hallmark of Japan’s stumble into decades of deflation in the 1990s.
Economists have long debated whether China is facing a similar "balance-sheet recession,” a theory Richard Koo, chief economist at Nomura Research, used to explain Japan’s "lost years.” He believes families and businesses, spooked by falling asset prices, focused on clearing debts and stopped spending in the economy.
While China’s current situation has clear differences to Japan’s predicament a "balance sheet recession” remains a real risk, said Lynn Song, chief economist for Greater China for ING Bank in Hong Kong.
"We already see some worrying signs of widespread pessimism setting in,” he said. "It remains of vital importance to stabilize asset prices before this sort of mindset becomes too entrenched.”
Other economic indicators are also pointing to a deterioration in domestic demand that has dragged on the economy this year.
Core inflation, which strips out volatile food and energy costs, rose just 0.4 per cent in July, the least since January. That came after economy-wide prices declined for five straight quarters, in the longest slide since 1999.
Data due Thursday (Aug 15) is expected to show retail sales remained sluggish, despite a slight improvement thanks to a more favorable base of comparison and the summer holiday season. A key gauge of Chinese services activity that covers the retail industry was on the brink of contraction for the first time since last year in July.
China’s bond markets are reflecting concerns the country faces a period of stagnation, subdued inflation and low interest rates. Yields have fallen to record lows across the curve and corporate bond spreads have narrowed as investors flocked to fixed income in favor of stocks, despite pushback from Chinese authorities.
Japan’s government bond yields were depressed for an extended period of time during its "lost decades.”
The People’s Bank of China has intervened repeatedly with verbal warnings and regulatory action in the government bond market in recent weeks. Policymakers are concerns about a negative feedback loop between falling yields and weakening expectations for the economy.
Ren Zeping, a well-known analyst who previously served as chief economist at China Evergrande, said China’s situation had "similarities with Japan’s balance-sheet recession in the 1990s.” High households savings, weak loan demand, low consumer and asset prices as well as high real borrowing costs all had parallels, he wrote in a Wednesday (Aug 14) note.
Despite those commonalities, economists have pointed to major economic differences that suggest China may not sleepwalk into Japan-style stagnation anytime soon.
The debt-to-gross domestic product ratio for the household sector has largely flat-lined since the pandemic, while that debt level for the corporate sector – which include state-owned enterprises that are less sensitive to demand shifts – has kept rising.
"There isn’t a significant contraction in liabilities,” said Larry Hu, head of China economics at Macquarie Group Ltd To determine a balance sheet recession, "we need to at least see that companies are deleveraging.” – Bloomberg
