Pushing on a Broken String

Cyclical momentum in China’s economy is slowing, deflationary pressures are rising, and the PBOC has initiated a cycle of cutting banks’ funding costs to reverse the rise in real interest rates and reduce corporate borrowing costs. But the more significant obstacle to policy support for the economy is a capacity problem in expanding credit, because of stress within China’s financial system impacting smaller banks.

The restructuring of Harbin Bank over the weekend was just one of a steady drumbeat of recent events showing that many of China’s smaller financial institutions are under pressure from tightening wholesale funding conditions within China’s interbank market, and defaults among banks will increase in the next few years. How Beijing manages these events will be critical for financial system stability, but in the short term, corporate credit growth will continue to slow, and activity growth will follow in early 2020.

Posted December 4, 2019
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