Xi's Private Lending Push Risks Being Hamstrung at Local Level

(Bloomberg) -- China's drive to funnel more credit to private companies is set to hit resistance from banks controlled by local governments.

“I'm not expecting a big reversal in the flow of loans in favor of private companies any time soon,” says veteran China watcher Nicholas Lardy of the Peterson Institute for International Economics in Washington. “There's so much lending from city and rural commercial banks that's just blowing up their balance sheets to support very under-performing local state companies.”

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After a crackdown on unregulated lending slashed funding to the private sector, last year the government launched an unprecedented campaign to push banks to give more to private companies. Non-state firms contribute 60 percent of gross domestic product and 80 percent of employment -- and the intensity of the policy response reflects the need to squeeze out more growth from an economy that expanded at the slowest pace in almost three decades last year.

China therefore needs to increase its productivity, as the supply of cheap labor is running dry and the economic boost from capital investment is weakening. Should these current efforts to boost the nimbler, more profitable private sector fail, the nation will miss out on possible growth and efficiency.

However, local lenders will have limited room to boost credit to private-sector companies, says Lardy, author of the recent book "The State Strikes Back: The End of Economic Reform in China?" That's because local governments depend on inefficient state-owned enterprises for taxes and employment, so while they will ensure that they get loans from city and rural commercial banks, it's uncertain whether they will jump to the rescue of private firms.

Even though the local state-owned enterprises often use borrowed funds to pay taxes, it's an important revenue source that officials are loathe to lose, Lardy says. Fixing the situation would require an overhaul of the nation's fiscal system to ensure a more stable revenue source for local governments, he says. That's been discussed many times over the years, but the last big reform was in the mid-1990s.

In addition, Lardy remains unconvinced about President Xi Jinping's commitment to the cause, despite his declaration of "unwavering" support for the private sector.

“All he's talked about on the enterprise side is making state enterprises bigger,” he said. “The evidence now is strongly in favor of the theory that Xi Jinping wants more control. That's what he's emphasized over and over again and he sees a big state sector as an element of control.”

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To contact Bloomberg News staff for this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net

To contact the editors responsible for this story: Jeffrey Black at jblack25@bloomberg.net, James Mayger

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