Unhealthy impulses

China's faltering GDP is a question of credit

China's first-quarter GDP growth of 7.7 per cent may have missed expectations. The real disappointment is that it did so in spite of a 58 per cent increase in financing. Though credit is flowing in the world's second biggest economy, it is going to ever less productive places.

When it comes to creating the next dollop of growth, what matters isn't how much funding is already out there, but the increase from one period to the next. This is sometimes called the "credit impulse". More new lending should in theory lead to greater output. Conversely, if lending increases, but by less than in previous years, the total stock of credit will go up, but growth may not.

In China, the credit impulse from banks to companies has gone into reverse. China's banks lent 12 per cent more in the first quarter of 2013 than they did a year earlier - but all of that increase went to households. The flow of new lending to corporate borrowers contracted by eight per cent, creating a drag on growth.

Other kinds of "shadow" finance have filled the gap. Loans made through trust companies, corporate bonds and bill financing - where banks let companies cash in each others' IOUs - expanded rapidly. That may help some cash-starved companies stay afloat. Even stripping out lending to households, new financing provided to the economy in the first quarter still increased by more than half.

But not all finance is equally useful. Much shadow credit may be going to unproductive uses, like speculating on property, or keeping unviable businesses alive. Money spent trading land or existing buildings doesn't contribute directly to economic output. New construction, which has relied heavily on trust lending, does contribute to GDP, but is vulnerable to a correction in inflated local property markets.

That problem with this lesser financing is simple: it takes ever more to create the same kind of growth. At the going rate, China will generate 25 trillion yuan of new financing in 2013, or around half of last year's nominal GDP. That's an urgent warning that it's time to start directing credit in a more efficient way.