BEIJING -- China's central bank has started backtracking on efforts to pare down swollen company and local-government debt, admitting that its strategy has caused a credit crunch.
Yi Gang, governor of the People's Bank of China, recently apologized for the bank's policy failure, which he said has led to difficulty in private-sector financing.
With the Chinese economy cooling due to the escalating trade war with the U.S., Beijing is likely to temporarily shelve its structural reform initiative put in place to lower dangerously high debt levels.
The central bank's policy "lacked consideration" and caused a "credit contraction," making it even more difficult for private-sector companies to raise necessary funds, Yi said in an interview published by China's state-run Xinhua News Agency on Nov. 6.
It is extremely rare for the chief of a Chinese government organization to admit a policy failure.
In early 2018, Beijing set out to reduce excessive debt carried by state-owned enterprises and local governments in order to avert a looming financial crisis.
The centerpiece of the strategy has been a crackdown on "shadow banking" by imposing regulatory restrictions on wealth-management products that target well-off investors. These products are common in the shadow banking sector and generate massive flows of money that are too complicated for regulators to track.
The war on these shady investment vehicles has been led by Yi and Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission. Both are reform-minded, internationally renowned experts in economics.
Controlling the risk of a financial meltdown by reducing debt was a priority cited by President Xi Jinping during last year's Communist Party National Congress, and the measures to rein in shadow banking produced immediate results.
In 2017, 3.6 trillion yuan ($520 billion) was raised by shadow banks. But in the first 10 months of this year, the sector's assets shrank by 2.6 trillion yuan as the amount repaid surpassed new borrowing -- a credit contraction of 6.2 trillion yuan.
The main customers of shadow banks are usually shell companies set up by local governments to raise funds for infrastructure, and private-sector companies that cannot borrow from normal banks.
Beijing's main target was the heavily indebted shell companies, which resulted in stalled infrastructure projects. Some local governments have even fallen into arrears, forcing municipalities to ask provincial governments for help while leaving employee salaries unpaid. Private-sector businesses that cannot receive this support, however, have nowhere to turn for financing.
Chinese banks have traditionally targeted state-owned enterprises for lending, with the private sector accounting for only a quarter of all bank loans to companies. Now, as shadow banks shut off credit, many private companies have become strapped for cash. These companies accounted for three quarters of all corporate bond defaults in the July-September quarter, a record high.
But authorities failed to quickly address the failings of the crackdown. When a securities analyst in May criticized Beijing for targeting private sector debt rather than state-run businesses, Guo vowed to debunk the analyst's argument.
In addition, when China's economic slowdown became evident during the summer, Xu Zhong, the central bank's research head, authored an article criticizing the Ministry of Finance for failing to address the credit crunch. The ministry vehemently rebutted the argument, resulting in a rare public spat involving the bank.
The controversy reached such levels that Xi was forced to intervene. On Nov. 1, he promised to solve the credit crunch in a meeting with the heads of private businesses.
Despite being Xi's top priority, the drive to reduce debt will most likely be put on hold. In its quarterly monetary policy report for the July-September, the PBOC promised to keep the economy on a stable growth path while working to reduce debt and enhance oversight of financial services.
This suggests that the central bank will not do anything that might hurt the economy, clearly backing away from its rhetoric in the January-March report, in which the bank vowed to maintain its debt-reduction policy.
Chinese commercial banks are not eager to lend money to the private sector because they earn handsome profits from low-risk loans to state-owned enterprises.
Despite all the talk about liberalization of interest rates on loans and deposits, regional industry organizations still take the lead in determining the rates.
In addition to Yi, who was forced to apologize for the policy error, Guo was also pressured to respond. In an interview on Nov. 7, he pledged to set targets for private-sector bank loans.
Bank shares plunged after Guo's remarks, with one analyst echoing current market sentiment. "Who supervises the banking regulators?" he asked.