Recent moves will reassure financial markets. Nevertheless, excess credit growth raises the risk of a crash in China in a few years’ time.

Lending to the economy reached record levels in China in January, suggesting that the authorities are prepared to do more to support growth. A stabilisation of the yuan and an admission by the authorities of mistakes in their approach to financial markets are also positive signs. Market fears around China may therefore temporarily abate. However, reliance on credit expansion to sustain economic growth is storing up problems for the future.
Total lending in China (credit from all sources) rose to a monthly record of 3.42trn yuan (USD520bn) in January, up from 1.82trn yuan in December and above expectations of 2.2trn yuan. Local-currency lending by domestic banks increased to 2.4trn yuan, also a record, compared with expectations of 1.9trn yuan.

There had already been some expectation that January would be a big month for lending, which was factored into estimations. First, banks have fresh lending quotas for the new calendar year and tend to front-load, lending especially heavily in January. Second, lending was accelerated by the Chinese new year, which fell 11 days earlier than in 2015. However, the surge in credit exceeded even these expectations.

A major turnaround in market sentiment appears unlikely in the short term, given continued concerns over growth and policy, as well as a likely poor corporate results season.

Chinese equity markets experienced a substantial sell-off in early January, with the CSI 300 losing 7% on both 4 and 7 January. This sent jitters across global financial markets. The latest bout of market instability in China does not appear to have been related to any change in the country’s economic fundamentals. Rather, a conjunction of factors triggered a rise in negative sentiment. Noise from elsewhere—notably the ongoing slide in the oil price, the North Korean nuclear test and increased tensions in the Middle East—exacerbated the situation.
Sell-offs highlight uncertainty An initial trigger for the market slide appears to have been that the Caixin/Markit manufacturing PMI fell again in December, to 48.2, from 48.6 in November, on data released on 4 January. This was the tenth consecutive month of contraction. However, it should not have triggered such a sharp sell-off. The official manufacturing PMI released a few days earlier had shown a slight improvement in December to 49.7, from 49.6 in November. Moreover, although manufacturing is contracting, services and consumption continue to perform reasonably well. The official non-manufacturing PMI was at 54.4 in December, up from 53.6 in November.