China’s Economic Schizophrenia on Display as it Seeks to Spur Growth While Reigning in Lending

Over the last two days, China’s debt, equity and currency markets have been roiled by competing, often contradictory, objectives of Chinese leadership — the continued fueling of growth while reigning in already excessive debt.  China’s largest banks are pressing the Central bank to ease restrictions on lending out deposits due to their squeezed profitability.  A rare drop in deposits — as customers are attracted to higher-yielding products — is compelling these banks to curtail lending.  A planned deposit-insurance system could push up bank funding costs even further and trigger rate hikes to maintain competitiveness.

Against this backdrop, China experienced its largest market drop in five years yesterday after a surprise move to clamp down on lending, which is now over 250 percent of GDP.  Specifically, regulators banned investors from using low-grade corporate debt as collateral to borrow cash.  The bond market fell on this news and the yuan experienced its largest two-day decline against the dollar ever recorded.

This kind of schizophrenic and volatile economic management is becoming more prevalent in China as it faces fewer options to maintain economic growth above the politically-sensitive 7% threshold.  In short, investors and creditors can likely expect considerably more such roller-coaster rides in the Chinese markets in 2015.