Don't be fooled by the Chinese banks' strong rebound of TSF in March

Barclays warns it will not be sustained.

According to Barclays, March new loans and total social financing posted a strong rebound, to levels seen in January. Total social financing (TSF) surged to CNY2.54trn, compared with 1.07trn in February and 2.54trn in January.

Here's more from Barclays:

New loans were CNY1.07trn (Barclays: 950bn, consensus: 900bn), compared with 620bn and 1.07trn previously. Based on the usual guidance of a quarterly lending pace of 3:3:2:2, the Q1 outturn implies full-year new loans at ~CNY9.2trn.

This is higher than our expectation of CNY8.5-9trn (2012: 8.2trn). The CNY6.16trn TSF in Q1 would point to +CNY20trn for the full year, higher than the upper bound of our ballpark forecast of CNY18trn (2012: 15.8trn). The strong money and credit data also suggest some upside surprises to our already above-consensus FAI growth forecast.

We maintain our view that such strong expansion of TSF or new loans in Q1 will not be sustained. We expect the monthly numbers to come down after regulators strengthen quota control. The strong Q1 results reflect pent-up demand from end-2012 and a pickup in demand post the Chinese New Year holiday. But the key question remains, how much of the rising demand (or total financing) will or should the central government allow to be satisfied?

Despite increasing funding constraints, local governments have resorted to trust financing and bond issuance and enjoyed low financing costs not compatible with the underling risks, due to a perceived implicit guarantee or bailout prospects.

Moreover, M2 growth has remained elevated at 15.7%, compared with 15.2% and 15.9% previously. This is significantly higher than the 13% full-year target set by the PBoC. While M2 growth has become a less accurate indicator with the rapid financial disintermediation, the recent surge is real and associated with rapid loan growth and capital inflows.

Should the central bank be serious about its target, we would expect some form of tightening (on liquidity or interbank rates or window guidance) to bring down the loan growth. The PBoC has kept the 7d repo rates at 3.3% in the past week. That said, we also maintain our judgement of 'no dramatic tightening' in TSF, after the latest CBRC regulations on wealth management products.

We have noted that there are some similarities between the start of the 2013 and the start of 2011, with respect to banks' on-balance-sheet lending impulses. We think this likely reflects the following factors: 1) strong effective demand in both years in contrast to that in early 2012; 2) loan to deposit ratio is less a constraints on banks from the supply side in contrast to that in 2012;

and 3) Chinese New Year was in February in both years. The macro environment, however, is different. In 2011 the economy was growing strongly at 9.7% and inflation was at 5.1%. Amid inflation and overheating concerns, the PBoC raised interest rates and hiked the RRR multiple times. Now, the economy is growing at ~8%, inflation is moderate at 2.4%, and the global environment remains fragile.

Also interestingly, the composition of the TSF changed in March 2013 versus January 2013 and 2011, which we believe reflects different thinking, the details of the CBRC regulations, and the banks' responses. Increasing debt financing and trust loans offset the decline in bankers’ acceptance bills.

Total off-balance-sheet lending came down to CNY880bn in March, compared with 997bn in January. Bankers’ acceptance bills fell markedly to CNY274bn, from CNY580bn in January, while trust loans rose to CNY431bn, up from 211bn in January.

Entrusted loans were CNY175bn vs 206bn in January. Meanwhile, the bond market continues to expand: net new corporate bond financing increased to CNY387bn in March, compared with CNY222bn in January. By Q1 2013, the total funds from off-balance-sheet lending and direct financing had risen to 33% and 13%, respectively, compared with 23% and 16% in 2012.

Meanwhile, February net PBoC FX purchases declined from CNY684bn in January to CNY295bn. This nonetheless confirmed sustained demand for the CNY. With accommodative monetary conditions expected in the US and EU, Japan embarking on an aggressive expansion of its monetary base, and Chinese economic growth expected to stabilise around 8%, this suggests to us that 2013 will see greater risks of capital inflows for China, rather than two-way movements in the CNY or capital outflows as in 2012.

Growth and return differentials (not adjusted for risks) also suggest a more liberalised capital account in China will likely lead to a net inflow rather than net outflow in the near term, in our view. We maintain our 2% appreciation forecast for USDCNY in 2013. The quarter-end FX reserve stood at USD3.44trn, slightly up from USD3.31trn at end of 2012, suggesting reduced PBoC intervention.