Chongyang Oct 2020: Change of Credit expansion and industry structural upgrade

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A different path of credit expansion

In August, social financing size increased to 3.58 trillion RMB which is 1.38 trillion RMB greater than last year. This tremendous increase exceeds the market expectation of 2.66 trillion RMB. The high level of growth continues. Even deducting the impact of the new issue of government bonds, credit supply is still at a relatively high level, indicating a new credit expansion. For a long time, one argument thinks that credit expansion is less likely to happen without loosening the limits on the real estate sector which is considered as the main carrier of credit supply. However, according to Chongyang’s “Credit Impulse” model, from the beginning of early 2019, China’s economy entered a new era of credit increase, but this period had a quite different development path and internal structure compared with the past.

From the perspective of the development path, credit expansion is not quite smooth since early 2019. Admittedly, the real estate which has been the pillar industry for China’s long-term economic development is becoming a carrier for each round of credit expansion. From financial institutions to other industries, there is inertial thinking that credit expansion is almost equivalent to real estate expansion. Therefore, under the circumstance of strict regulation and control of the real estate, when financial regulations encourage financial institutions to expand credit and loan to the real economy especially middle and small-sized businesses in early 2019, financial institutions are overwhelmed which causes disorders in credit release. Following the societal consensus of real estate regulation, this mindset is gradually being reversed. Non-real estate industries’ borrowing has become an important carrier for this credit cycle. The internal structure modification has also become another important characteristic of this period.

Looking at areas where new loans are added, incremental household loans(mainly from the mortgage) has a decreasing proportion each year, from 46% in 2018 to the current 36%. Newly added business section loan is relatively increasing. This loan releasing direction shows a wax and wane of domestic financial resources’ investment is getting rid of the constraints from real estate. More resources are focusing on the non-real estate area. From micro- survey we also found that manufacturing has become the main carrier of this round’s credit expansion. The secondary sector is replacing real estate and becoming the stabilizer of China’s economy.

More credit expansion on manufacturing structural upgrade

Admittedly, China’s manufacturing sector in general does have sufficient capacity. Some fields even have excess capacity. We believe that the manufacturing sector is not strong enough as a driver of the rapid boom of China’s economy. Hence, This round manifests a clear structural characteristic of the carrier’s credit initiation which is also the transformation and upgrading of the industry. These upgrades will be more evident in the following two areas: 1) Consumption upgrade; 2) Import substitution. The supply side’s digitalization transformation is making these demand side’s upgrades possible.

First of all, with the accumulation of residents’ wealth and an increase in income level, new consumption energy is accumulating. Consumption upgrade is forcing midstream manufacturing to upgrade. Take the household appliance industry as an example: in recent years, we have seen a continuous increase in the market share of medium and high-end products. Its growth is distinctly faster than the whole industry. To keep up with this consumption upgrade trend, one home appliance manufacturer developed a high-end series with its more advanced technology and a better design. The series renovates a product line of the refrigerator, washing machine, air conditioning, and other traditional home appliances, in order to build an outlook of a “Smart Home”.

Additionally, under new pressure from the pandemic and geopolitical conflicts, China is unprecedentedly prioritising the completion and security of its supply chain. It also hastens vigorous investment demand to improve weak lines at crucial parts of the supply chain. In particular, substituting of localization of high-end equipment is a classic example. In many areas of manufacturing, high-end equipment mostly is dependant of overseas supply, while domestic equipment manufacturers are mainly competing at the low-end market. The conflict between the global economy and trade intensifies, especially with the pandemic which boosts the research of domestic high-end products, supplied by domestic equipment. We believe, with the increasing interaction between upstream and downstream production lines, local demand can be better fulfilled. Meanwhile, compared with foreign brands, our cost advantage can also alleviate burdens for downstream sourcing company and finally improve the competitive power of China’s whole supply chain.

How should the manufacturing sector respond to the two main trends of demand-side upgrades? Are Chinese manufacturing sectors are equipped with conditions for transformation and upgrading? The answer we have is digitalization transformation. For the moment, the development is visible in the areas including 5G, big data, IoT, cloud computing and other digitalized aspects. We might be at the leading position in some areas already. With the maturity of digitalized technology, it is empowering the traditional manufacturing industry which will dramatically improve supply chain efficiency. With reduced costs, it also improves product quality which can better satisfy terminal demand. One example from the home appliance industry: to integrate and reengineer the traditional end-to-end response, raw material procurement and logistics, the industry has a more accurate and timely response to terminal demand. Thus, the traditional production line can be enlivened, and flexible manufacturing can be achieved.

History does not just repeat itself, but it might rhyme in the same way. China’s economic cycle is different from what it used to be. It is expected to be led by the manufacturing industry to resume its recovery. To locate bull stock in this round of economic cycle, investors should refer to the experience, and more importantly, look forward to the future.




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