Pressure on Beijing to loosen monetary policy remains following the relatively low levels of credit extended in July. 

The overall supply of credit from China’s formal and informal financial systems in Q1 this year is likely to have contracted by around 10% YoY in spite of a resurgence in formal bank lending in March, according to China Confidential research.

China’s underground lending rate, a proxy for the market price of capital, eased for the second month in a row in February as demand for credit softened and liquidity conditions improved, according to a China Confidential survey of 36 shadow banks in six provinces.

A slowdown in underground lending represented one of the key events in January, with 52% of respondents among 39 private lenders interviewed by China Confidential in six provinces reporting a loss of business in January compared to December. Non-performing loans among underground banks also rose, posting their highest reading since this monthly survey began in January 2011. Although Chinese New Year, which fell this year in January and last year in February, makes comparisons inexact, we think that the lacklustre responses from the underground segment suggest a slowing shadow finance industry as demand from property developers slows.

The authorities have begun 2012 by showing an intent to keep defaults to a minimum in both property and LGFV segments to avoid systemic risk.

Net outflows of “hot money” from mainland China to various locations, including Hong Kong and Taiwan, have become the most important variable in assessing liquidity conditions, as well as Beijing’s likely liquidity and monetary policies. We think the net outflows of foreign currency are set to persist in December, following two consecutive months of outflows in November and October, applying mounting pressure on authorities to ease liquidity policy, probably by cutting the bank required reserve ratios again. A cut over the coming few weeks would seem likely, following a 50 bp cut earlier in December.

These are days of key change in China’s financial system. New credit extended by the shadow finance system slowed appreciably in October while new loans from the formal banking system grew strongly, reversing the pattern of recent months as Beijing started to ease its liquidity policy and turned up the heat on underground banks.

New lending by China’s formal and informal financial system slowed significantly in September, providing fresh evidence for the increasingly pronounced moderating trend in overall GDP growth. We continue to think that the People’s Bank of China (PBoC) is showing tendencies toward loosening liquidity policy.