Credit growth in China is slowing gradually as policymakers seek to navigate the world’s most prominent recovery from the pandemic without fuelling unsustainable indebtedness.

China last week kept its benchmark lending rate unchanged for the 12th month in a row, but other indicators show that Beijing, which exercises greater control over its state-dominated banking system than most major economies, is using other policies in a bid to dampen down the risk of overheating in its unbalanced, industry-heavy recovery.

Total social financing, the country’s main gauge of credit growth which measures lending across the domestic financial system, rose by 12 per cent year-on-year in March, its slowest pace since April last year, according to official data released this month.

Mike Riddell, a lead fund manager at Allianz Global Investors, warned that China’s credit cycle is “the main global growth dynamic to watch” because it had “driven a lot of global reflation” so far.

Any further tightening would drag on global growth as it recovers from the pandemic, he said.

“Already China’s been the first major economy to tighten policy,” said Julian Evans-Pritchard, senior China economist at Capital Economics.

The latest signs of a deceleration in credit growth come after the central bank asked lenders to rein in their activity in February. Policymakers have targeted the property sector through the so-called “three red lines” policy, which aims to limit major developers’ leverage as measured by three balance sheet metrics.

The approach is designed to constrain their access to credit, which has helped drive a construction boom that pushed steel production to its highest ever level last year.

The rate of credit growth had risen sharply by the middle of 2020, encouraged by a cut in the one-year loan prime rate — one of several used to guide borrowing costs — which China introduced last April as the economic consequences of the pandemic took hold.

But by late 2020 credit growth had begun to fall compared with trend output growth according to analysis from Evans-Pritchard which adjusts for seasonality. He added that stimulus in China relies heavily on behind-the-scenes guidance to banks.

“The slowdown in credit growth over the rest of the year will be driven by policymakers’ deleveraging initiatives — the most significant one being the deleveraging in the property sector,” said Michelle Lam, greater China economist at Société Générale.

Interest rates on the country’s bond market also rose late last year and remain elevated. The 10-year government bond trades at 3.16 per cent, compared to 2.5 per cent a year ago.

“On the capital markets side there’s definitely been tightening,” said Zhikai Chen, head of Asian equities at BNP Paribas Asset Management.

Line chart of Total social financing, annual rate of change (%) showing Credit growth is slowing in China

Last year’s increase in credit growth pushed China’s debt-to-GDP ratio to an estimated 281 per cent according to JPMorgan — the highest level on record. China is not alone — indebtedness has risen sharply around the world as governments seek to spend their way out of the pandemic — but Chinese policymakers are more concerned than most about the resulting debt burden, according to analysts.

Guo Shuqing, the country’s top banking regulator, in March warned over bubble risks overseas and in the domestic real estate market, and in January, a People's Bank of China adviser raised concerns that loose liquidity might fuel an asset bubble.

“They seem much more concerned about the debt sustainability impact of Covid than a lot of other countries, which is why they’re moving so quickly to normalise policy,” said Evans-Pritchard.

But Chinese policymakers are taking a sector-specific approach rather than raising rates — which would ripple across the whole economy — in part because the recovery is patchy.

Although last week’s gross domestic product data documented a strong rebound from the depths of the first quarter last year, quarter-on-quarter growth was disappointing at just 0.6 per cent. Inflation has remained close to zero, though producer prices have begun to rise rapidly since the start of this year.

The government said in March at the National People’s Congress that its macroeconomic policies would remain supportive.

“It appears that the economy has slowed,” said Dariusz Kowalczyk, an economist at Crédit Agricole. “I think that’s why money market rates have been guided lower by the PboC, to ensure the economy is doing OK.”

Interbank rates have risen — the three-month Shanghai Interbank Offered Rate is at 2.6 per cent, compared to 1.4 per cent last April, although it is below its November level of 3.1 per cent.

Steve Cochrane, chief economist for Asia Pacific at Moody’s Analytics, expects no rate rises until next year. He pointed to the risk that “small and medium sized enterprises would be starved of credit” if overall rates were increased.

While global attention has focused on the US, where President Joe Biden’s fiscal stimulus package has boosted global economic growth forecasts, some investors point to the shift in China’s lending patterns as an under-regarded indicator for the trajectory of the global recovery.

“The US fiscal spend completely dominates the inflation debate,” said Bhanu Baweja, chief strategist at UBS investment bank. “I'm surprised by the extent to which people are not talking about the Chinese credit impulse.”

Additional reporting by Wang Xueqiao in Shanghai