Tianfeng Song Xuetao: Revisiting the "De-Financialization" of the Economy

The financial data in May continued the previous logic. Due to factors such as regulated manual interest rate adjustments and deposit diversion, M1 decreased by -4.2% year-on-year for two consecutive months. Influenced by factors such as financial data "squeezing liquidity" and weak demand for physical financing, RMB loans increased by 950 billion yuan in May, a decrease of 410 billion yuan year-on-year. Only social financing, supported by government bonds and the low base of corporate bonds from last year, increased by 513.2 billion yuan year-on-year, pushing the year-on-year growth rate of social financing up by 0.1 percentage point to 8.4%.

When M1 has negative growth for two consecutive months and new credit is weak, domestic economic data performs better than financial data, and the real economy sector is not facing a shortage of funds. The support of credit funds for the economy is not weak.

The BCI corporate financing environment index in May increased by 0.8 percentage points to 45.5%. The year-on-year decline in corporate loan interest rates exceeded 0.2 percentage points, maintaining around 3.7%, a historical low.

The yield on 5-year AAA-rated corporate bonds decreased from 2.51% at the beginning of the month to 2.38% at the end of the month.

At the end of May, the balances of loans for high-tech, "specialized and innovative", and small and medium-sized technology enterprises increased by 11.6%, 15.9%, and 19.2% year-on-year, significantly higher than the 9.3% loan balance growth rate.

Exports in May increased by 7.6% year-on-year, exceeding market expectations. PPI increased by 0.2% month-on-month, turning positive for the first time since October 2023. High-frequency data such as blast furnace operating rates and semi-steel tire production capacity utilization also improved month-on-month.

The decoupling of financial data and economic data is a manifestation of economic "de-financialization".

With the past high-debt economic growth model, even if credit growth is slightly lower than before, it is sufficient to support stable economic growth.

As the leading role of financial data in economic data gradually weakens, the market should gradually reduce its focus on total financial indicators and should directly seek support from economic data.

Firstly, as real estate sales enter a continuous downward cycle, the channel for the conversion of household deposits to corporate deposits is blocked, and the indicative significance of M1 for the economy has also declined.

The main reason for the year-on-year negative turn of M1 in April and May was the impact of regulated manual interest rate adjustments and wealth management diversion, reflected in a decrease of 800 billion yuan in corporate deposits in May and an increase of 1.16 trillion yuan in non-bank financial institution deposits. The impact of related factors on M1 may continue, but the decline in the year-on-year growth rate of M1 caused by this is not comparable to historical data, as recent M1 year-on-year declines are accompanied by some stabilization in the PMI

Even if short-term impact factors such as manual interest rate governance in the future have passed, under the background of economic transformation, M1 continues to decline year-on-year, and its leading significance to the economy will also weaken.

Previously, real estate was one of the main driving factors of the economy. With the recovery of real estate sales—residential deposits converted into corporate deposits (previously, mortgage loans accounted for about 60% of total new loans to residents, M1 increased, credit expansion)—improvement in cash flow of real estate companies, investment expansion (corporate deposits become current, real estate-related loans once accounted for about 40% of total new loans, M1 increased, loan expansion)—expansion of the post-cycle industry prosperity of real estate—economic recovery, under the transmission chain, M1 year-on-year, credit year-on-year growth rate/ social financing year-on-year growth rate will show characteristics leading the economic cycle.

In recent years, as real estate has entered a downward cycle, the leading indicative significance of M1 to the economy has declined. Since the end of last year, M1 has been oscillating downward as a whole, but PMI and first-quarter GDP data show that the economy is in a phase of weak recovery.

On the one hand, with the decline in real estate sales and falling house prices, it is difficult for residential deposits to be converted into corporate deposits, although in recent months, local governments have intensified real estate policies, the impact is mainly reflected in the second-hand housing sales market, which will not affect M1.

On the other hand, after the high-debt high-investment model in the past, the demand for leverage in the real sector has weakened, and the scale of loan-derived deposits has declined, making it difficult for M1 to rise significantly.

Secondly, for credit indicators, abundant outstanding loans and changes in credit entities mean that the indicative significance of new credit to the economy is weakening.

Before 2021, real estate was an important carrier of credit expansion, with the proportion of new real estate loans to total new loans averaging 32% from 2012 to 2020, and the ratio between the two reaching 45% in 2016.

As real estate enters a downward cycle, the support of real estate for credit weakens, and policies begin to actively guide credit funds to flow into low-debt sectors such as industry and services. The switch of credit entities will naturally drive down the credit growth rate.

Revitalizing outstanding loans can provide ample financial support for subsequent real sectors, but it will not be reflected in the credit growth rate.

Currently, the balance of RMB loans in China is as high as 248.7 trillion yuan, with some funds having low efficiency of use, and improving the efficiency of using outstanding loans has gradually become a focus of policy attention Taking industrial loans as an example, in recent years, financial institutions have significantly increased their credit support to the industrial sector. The scale of new medium and long-term industrial loans in China has increased from 590 billion yuan in 2019 to 48 trillion yuan in 2023, with the balance of medium and long-term industrial loans growing by 155% from 92 trillion yuan to 23.4 trillion yuan in the first quarter of 2024.

However, during the period of 2019-2023, the compound annual growth rate of manufacturing investment was only around 6.6%, significantly lower than the growth rate of medium and long-term credit. Credit supply has exceeded the financing demand of the real economy, leading to relatively low efficiency in the use of some credit funds. The amount of manufacturing investment corresponding to every 100 million yuan of new medium and long-term industrial loans has decreased from 37 million yuan in 2019 to 5.9 million yuan in 2023. Some enterprises have started to achieve "low borrowing and high deposit" arbitrage through methods like "manual interest supplementation," resulting in idle funds.

An article in the Financial Times also points out that the stimulative effect of credit allocation on economic growth has been weakening year by year. From 1953 to 1977, 1978 to 1993, 1994 to 2007, and 2008 to 2022, for every additional yuan of credit allocation in China, the corresponding increase in GDP was 1.636 yuan, 0.988 yuan, 0.935 yuan, and 0.489 yuan respectively, indicating a significant weakening of the driving effect. This implies the existence of a large amount of inefficient funds in the real sector.

Deposits and loans are two sides of the same coin, and M2 data also indicates that China's financial resources are currently sufficient, but the efficiency of funds in driving GDP is weakening. In recent years, the ratio of M2 to GDP in China has been continuously rising, significantly higher than that of major economies overseas. By the end of 2023, China's M2/GDP ratio was 2.3, much higher than the ratios of 0.76 for the United States, 1.06 for the Eurozone, 1.12 for the United Kingdom, and 1.63 for South Korea.

In this context, the central bank has started to emphasize the revitalization of inefficient existing loans and has increased governance over behaviors such as "manual interest supplementation" this year.

Although revitalizing existing loans may not translate into credit growth, it can still provide effective financial support for economic growth. For example, by retrieving inefficient loans and redirecting them to new growth areas, the idle funds previously used for arbitrage can be utilized for investments such as repaying overdue debts to small and micro-enterprises.

The end of the debt-driven model and the revitalization of existing funds also mean that the real sector no longer requires the same high credit growth rate as before. A decline in credit growth does not imply a decrease in the level of financial support to the real economy, but rather, indicators such as credit growth rate and M2 growth rate have a diminished signaling effect on the economy. **

Third, the decline in off-balance sheet financing and direct financing demand in infrastructure and real estate sectors has also weakened the indicative significance of social financing growth for the economy.

Social financing reflects the support that the real economy receives from the financial system, including bank loans, off-balance sheet funds (entrusted loans, trust loans, etc.), direct financing (corporate bonds, equity financing), government bonds, and so on. With economic transformation, besides credit, the demand for off-balance sheet funds, bond funds, and other forms of financing by the real economy is also declining.

In the past credit bond financing market, municipal bonds and bonds related to the real estate industry were the mainstay of bond financing. For example, from 2017 to 2019, the issuance of credit bonds in four industries including transportation, construction decoration, utilities, and real estate accounted for 42%.

However, affected by risks in the real estate credit market and factors such as hidden debt governance, the growth rate of corporate bonds in the social financing scope has rapidly declined. In May 2024, the year-on-year growth was 1.9%, significantly lower than the growth rates of social financing and credit. When credit supply is relatively abundant, the willingness of the real economy to obtain funds through trust loans, entrusted loans, and other channels is also not high.

On the surface, financial data has been affected by short-term factors such as governance manual interest rate adjustments and financial data "squeezing water". However, since 2022, the decoupling of financial data and economic data has begun to emerge, the debt-driven model is ending, and after the "de-financialization" following the "de-real estateization" of the economy, the indicative significance of financial data for the economy should gradually fade, with more focus on the economic data itself and the ongoing structural transformation