BEIJING – China’s first contraction in outstanding loans since 2005 has crystallized worries about a deepening downturn for the world’s second-largest economy.
Instead of putting money to work, households and companies are paying down their debt as they take a more dim view of their prospects, threatening a self-fulfilling cycle of economic underperformance. The longest deflation streak since at least the 1990s is also suppressing demand for borrowing, contributing in July to a 430 billion yuan (S$76.9 billion) decline in loans to the real economy – the most on record going back to 2002.
“Weaker loan demand tends to be a negative sign for future growth,” said Lynn Song, chief Greater China economist at ING Bank. “My biggest concern is the entrenched pessimism, which is the main reason for weak consumer and corporate borrowing appetite.”
The flow of credit will dictate the economic tempo for years to come. For Beijing, the challenge now is in how to lift languishing domestic demand that threatens to hobble growth in the long run, just as trade barriers abroad present a risk for China’s export engine.
Policymakers face a tricky balance. Officials are trying to heed a call by President Xi Jinping’s government to tackle price wars and reduce excessive competition without sparking a wave of job losses or further depressing sentiment among the very consumers they want to spend more.
That could be tough. State media said after the credit data on Aug 13 that reining in China’s overcapacity problem could have had a negative impact on loan demand.
Other factors were in play too.
The property market deteriorated while consumer subsidies slowed temporarily, weighing on household loans. Under pressure from intense price wars and US tariff threats, companies also dialled back their borrowing.
The only expansion in July materialised in bill financing, a tool used by banks to inflate lending when borrowing demand is weak.
While it may be too early to ring the alarm about the risk of a Japanese-style balance-sheet recession, “we do worry about the renewed weakness in the property market,” said Serena Zhou, senior China economist at Mizuho Securities Asia.
Beijing will likely find boosting demand difficult without stabilising the property market because it’s a store for almost 60 per cent of household wealth, based on a central bank survey in 2019. Now in its fourth year of decline, the housing sector may not bottom out until mid-to-late 2026, according to some estimates.
“If we do see a double dip in the property sector, the negative wealth effects will become a bigger overhang on consumer sentiment,” meaning “the government’s efforts at subsidizing consumption” would have been in vain, MrsZhou said.
China’s credit growth has been stuck in a low gear since 2022. Not even interest rate cuts by the central bank were able to reverse the slowdown in lending.
While industrial loans skyrocketed after the pandemic, their moderation in recent months shows that China’s formidable manufacturing machine also isn’t immune to feeble appetite for debt.
And as deflation in the economy becomes increasingly pervasive, it’s souring household and business expectations for future income and profit. The danger is that without a timely fix to reflate the economy, China may follow the footsteps of Japan and become trapped in decades of deflation and low growth.
What made the data appear even worse in July was local governments’ effort to resolve hidden debt – which involves selling bonds to repay loans and may have cut into bank credit volumes.
Financial News, a paper backed by the People’s Bank of China (PBOC), also singled out a campaign to ensure big companies are paying their small suppliers on time as a potential reason for poor borrowing demand from companies.
Ultimately, as policymakers try to rein in inefficient loans that are fueling overcapacity, the economic side effects threaten a steep fall in demand because of production curbs.
Authorities also need to overcome the resistance from local governments and banks, who have plenty of motivations to keep unprofitable – and even “zombie” – companies alive to maintain employment and avoid losses on their books.
That’s why the PBOC has taken an increasingly targeted approach when it comes to credit support, according to Xing Zhaopeng, senior China strategist at Australia & New Zealand Banking Group.
The central bank will pay increasing attention to the five sectors deemed important by top officials, including tech and green industries, shifting away from the kind of broad-based stimulus boost delivered for the entire economy in the past, he said.
Credit support “will be retreating in some areas and advancing in some areas, and the former will be plenty,” Mr Xing said. “It will mostly be the industries with overcapacity.” BLOOMBERG